We will review•the different types of deposits banks offerand,•which types of deposits are among themost profitable to offer their customers.We will examine how an institution’s costof funding can be determined and thedifferent methods of pricing deposits anddeposit-related services.
12-3• Types of Deposit Accounts Offered• The Changing Mix of Deposits and Deposit Costs• Pricing Deposit Services and Deposit Interest Rates• Conditional Deposit Pricing• Rules for Deposit Insurance Coverage• Disclosure of Deposit Terms• Lifeline Banking
12-51. Where can funds be raised at lowest possible cost?2. How can management ensure that there are enough deposits to support lending and other services the public demands?
12-6 Transaction (Payment or Demand) Deposits Making Payment on Behalf of Customers One of The Oldest Services Provider is Required to Honor Any Withdrawals Immediately Nontransaction (Savings or Thrift) Deposits Longer-Term Higher Interest Rates Than Transaction Deposits Generally Less Costly to Process and Manage Most held by private sector
An account used primarily to makepayments for purchases of goodsand services
Noninterest-Bearing Demand Deposits Interest prohibited by Glass-Steagall Most volatile and unpredictable source of funds Interest-Bearing Demand Deposits Negotiable Orders of Withdrawal (NOW) Money Market Deposit Account (MMDA) Super NOW (SNOW) Account
Technology which allows anydepository institution’s staffmember to search on screen for acheck or other document byaccount number, date, dollaramount or document number aswell as perform other functions
An account whose primarypurpose is to encourage thebank customer to save ratherthan make payments
Bump-up CD – allows a depositor to switch to a higher interest rate if market rates rise Step-up CD – permits periodic upward adjustments in the promised interest rate Liquid CD – permits the depositor to withdraw some or all of their funds without a withdrawal penalty
The maturity of the deposit The size of the offering institution The risk of the offering institution Marketing philosophy and goals of the offering institution
A stable base of funds that isnot highly sensitive tomovements in market interestrates and which tend to remainwith the bank
Deposit Amount(Millions of Dollars) Total Deposits Core Deposits Volatile Deposits = Total Deposits - Core Deposits 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Time
Effective October 28,2004 – permits depository institutions to electronically transfer check images The images are called substitute checks and is a legal copy of the check Protects depositors against loss Benefits institutions by reducing the cost of check clearing Substitute checks can be sent electronically instead of sending bundles of checks More Information: http://www.federalreserve.gov/
Banks insured through Bank Insurance Fund (BIF) Savings and Loans insured through Savings Association Insurance Fund (SAIF) Covers only those deposits payable in the U.S. Many types of accounts are covered up to $100,000 (temporarily $250,000) for each account holder within the same bank (even if different branches) Deposits placed in separate institutions are insured separately
Consumers must be informed of the deposit terms before they open a new account Depository institutions must disclose: Minimum balance to open Minimum to avoid fees How the balance is figured When interest begins to accrue Penalties for early withdrawal Options at maturity And the APY
12-20• Suppose that a customer holds a savings deposit in a savings bank for a year. The balance in the account stood at $2,000 for 180 days and $100 for the remaining days in the year. If the Savings bank paid this depositor $8.50 in interest earnings for the year, what APY did this customer receive?
The correct formula is: InterestEarned 365 APY 100 (1 ) Days in Period -1 AverageAccountBalance In this instance, $8.50 365 365 APY 100 (1 ) -1 $1036.99 Or, APY = 0.82 percent, Where the average account balance is: $2000x 180 days $100x 185days $1036.99 365days
12-22• The Glass-Steagall Act of 1933 – Federal Limits on Interest Rates Paid on Deposits – why?• Nonprice Competition• The Depository Institutions Deregulation and Monetary Control Act of 1980 ▫ Cost-Plus Pricing ▫ Historical Avg Cost Pricing ▫ Pooled Funds Approach ▫ Marginal Cost of Deposits ▫ Conditional Pricing ▫ Upscale Target Pricing ▫ Relationship Pricing
Estimating Unit Price Operating Planned OverheadCharged the Expense Profit from Expense Customer = Per Unit of + + Each Allocated to for Each Deposit Service Unit the Deposit Service Service Sold Function
Richman Savings Bank finds that its basic checking account which requires a $500 minimum balance, costs the bank $2.65 per month in servicing costs (including labor and computer time) and $1.18 per month in overhead expenses. The savings bank also tries to build in a $0.50 per month profit margin on these accounts. What monthly fee should the bank charge each customer? Following the cost-plus-profit approach, the monthly fee should be:Monthly fee = $2.65 + $1.18 + $0.50 = $4.33 per month
Further analysis of customer accounts reveals that for each $100 above the $500 minimum in average balance maintained in its checking accounts, Richman Savings saves about 5 percent in operating expenses with each account. For a customer who consistently maintains an average monthly balance of $1,000, how much should the bank charge in order to protect its profit margin?
If the bank saves about 5 percent in operating expenses for each $100 held in balances above the $500 minimum, then a customer maintaining an average monthly balance of $1,000 should save the bank 25 percent in operating costs.The appropriate fee for this customer would be: [$2.65 –(5x0.05)x($2.65)] + $1.18 + $0.50 = $1.9875 + $1.18 + $0.50 = $3.6675 per month.
Determines the bank’s cost offunds by looking at the past. Itlooks at what funds the bank hasraised to date and what those fundshave cost.
Determine the bank’s cost offunds by looking at the future.What minimum rate of return isthe bank going to have to earnon any future loans andsecurities to cover the cost of allnew funds raised?
Checkbook deposits Interest & noninteres t fund raising costs Total funds raised 100 percent - Percentage reserve requiremen ts and float Time & savings deposits Interest & noninteres t fund raising costs Total funds raised 100 percent - Percentage reserve requiremen ts and float Money market funds Interest & noninteres t fund raising costs Total funds raised 100 percent - Percentage reserve requiremen ts and float Owners equity Interest & noninteres t fund raising costs Total funds raised 100 percent - Percentage reserve requiremen ts and float $100 $200 $50 $50 .10 .11 .11 .22 $400 $400 $400 $400 1.00 .15 1.00 .05 1.00 .02 1.00 0 0.1288 12.88%
Many financial analysts wouldargue that the added cost (notweighted average cost) ofbringing new funds into thebank should be used to pricedeposits.
Marginal cost = Change in Total Cost = New interest rate x Total funds raised – Old interest rate x Total funds raised at old rate Change in total cost Marginal cost rate Additional funds raised
Gold Mine Pit Savings Association finds that it can attract the following amounts of deposits if it offers new depositors and those rolling over their maturing CDs the interest rates indicated below: Expected Volume Rate of Interest of New Deposits Offered Depositors $10 million 3.00% 15 million 3.25 20 million 3.50 26 million 3.75 28 million 4.00 Management anticipates being able to invest any new deposits raised in loans yielding 6.25 percent. How far should the bank go in raising its deposit rate in order to maximize total profit (excluding interest costs)?
The method of selling depositsthat usually sets low prices andfees initially to encouragecustomers to open an accountand then raises prices and feeslater on.
Schedule of fees were low if customer stayed above some minimum balance - fees conditional on how the account was used Conditional pricing based on one or more of the following factors The number of transactions passing through the account The average balance held in the account during the period The maturity of the deposit
First Metrocentre Bank posts the following schedule of fees for its household and small business checking accounts: For average monthly account balances over $1500 there is no monthly maintenance fee and no charge per check. For average monthly account balances of $1000 to $1500 a $2 monthly maintenance fee is assessed and there is a $.10 charge per check. For average monthly account balances of less than $1000, a $4 monthly maintenance fee is assessed and there is a $.15 per check fee. What form of deposit pricing is this? What is First Metrocentre trying to accomplish with its pricing schedule? Can you foresee any problems with this pricing schedule?
First Metrocentre Bank has posted a schedule of deposit fees that allows the customer service-charge free checking for average monthly account balances over $1500. Lower balances are assessed an inverse monthly maintenance fee plus an increased per-check charge as the average monthly account balance falls. This is conditional deposit pricing designed to encourage more stable, larger-denomination accounts which would give the bank more money to use and, perhaps, a more stable funding base. The fees on under-$1000 accounts are stiff which may drive away many small depositors to other banks.
Bank aggressively goes afterhigh-balance, low-activityaccounts. Bank uses carefullydesigned advertising to targetestablished business owners andmanagers and other highincome households.
The bank prices depositsaccording to the number ofservices purchased or used. Thecustomer may be granted lowerfees or have some fees waived iftwo or more services are used.
Some people feel that allindividuals are entitled to aminimum level of financialservices no matter their incomelevel.
12-42• What are the major types of deposit plans offered today?• What are core deposits, and why are they so important?• How has the composition of deposits changed in recent years?
12-43• A bank determines from an analysis of its cost-accounting figures that for each $500 minimum-balance checking account it sells, account processing and other operating costs will average $4.87 per month and overhead expenses will earn an average of $1.21 per month. The bank hopes to achieve a profit margin over these particular costs of 10 percent of total monthly costs. What monthly fee should it charge a customer who opens one of these checking accounts?• Unit Price Charged Per Month = $4.87 + $1.21 + 0.10 x ($4.87 + $1.21) = $6.69
Sets the maximum delay forreceipt of deposit credit bankscan use and requires the bankto notify customers of theirpolicies for making fundsavailable
Types of Deposits Determinants of interest rate paid Core deposits Deposit pricing methods Cost plus Marginal Historical Market penetration Pooled Deposit fee schedules Additional deposit pricing types Upscale Relationship Lifeline or basic Expedited funds availability act