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Chapter Twelve
Managing and Pricing Deposit Services
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Key Topics• 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
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Key Issues Depository Institutions Are Faced With:1. 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?
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Recent Trends
•Pricing Schedules and Competitive Maneuverings of Other Financial Institutions
•Competitors: Mutual Funds, Credit Unions, Cash Management Accounts at Brokerage Firms and Insurance Companies, and Interest-Bearing Investment Accounts Offered by Securities Firms
•An Important Executive Position of the Chief Deposit Officer
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Types of Deposit Accounts•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
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Transaction Deposit
An Account Used Primarily to Make Payments for Purchases of Goods and Services
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Types of Transaction Deposits•Noninterest-Bearing Demand Deposits▫Interest Was Prohibited by Glass-Steagall
Act▫One of the Most Volatile and Unpredictable
Sources of Funds▫Most Deposits are Held by Business Firms
• Interest-Bearing Demand Deposits▫Negotiable Orders of Withdrawal (NOW)-
hybrid savings instrument▫Money Market Deposit Account (MMDA) and
Super NOW due to Garn-St Germain Depository Institution Act of 1982
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Nontransaction (Savings or Thrift) Deposit
An Account Whose Primary Purpose is to Encourage the Bank Customer to Save Rather than Make Payments
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Types of Savings or Thrift Deposits
•Passbook Savings Account•Statement Savings Deposit•Time Deposit (CD)•Individual Retirement Account (IRA) -
The Economic Recovery Tax Act of1981•Keogh Deposit – have tax benefits•Roth IRA – The Tax Relief Act of 1997
Allows Non-Tax-Deductible Contributions
•Default Option Retirement Plans – The Pension Protection Act of 2006
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Popular Types of CDs
•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
12-10
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Interest Rates on Deposits Depend On:•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
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The Changing Composition of Deposits in the US
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Core Deposits
A Stable Base of Funds that is Not Highly Sensitive to Movements in Market Interest Rates (Low Interest-Rate Elasticity) and Which Tend to Remain with the Bank
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Check 21 and Substitute Checks•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/
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FDIC Insurance Coverage•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 (increased to $250,000 until year-end 2009 by the Emergency Economic Stabilization Act of 2008) for Each Account Holder within the Same Bank (Even if Different Branches)
•Deposits Placed in Separate Institutions are Insured Separately
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Truth in Savings Act•Consumers Must be Informed of the
Deposit Terms Before They 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
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Pricing Deposit-Related Services
•The Glass-Steagall Act of 1933 – Federal Limits on Interest Rates Paid on Deposits – why?
•Nonprice Competition•The Depository Institutions Deregulation
Act of 1980▫Cost-Plus Pricing▫Marginal Cost of Deposits▫Conditional Pricing▫Relationship Pricing
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Cost Plus Profit Deposit Pricing
Unit Price Charged the
Customer for Each Service
=
Operating Expense
Per Unit of Deposit Service
+
Estimating Overhead Expense
Allocated to the Deposit
Function
+
Planned Profit from
Each Service Unit
Sold
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The Marginal Cost Approach: Historical Average Cost Approach
Determines the Bank’s Const of Funds by Looking at the Past. It Looks at What Funds the Bank Has Raised to Date and What those Funds Have Cost
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Pooled Funds Approach
Determine the Bank’s Cost of Funds by Looking at the Future. What minimum Rate of Return is the Bank Going to Have to Earn on Any Future Loans and Securities to Cover the Cost of all New Funds Raised?
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Using Marginal Cost to Set Interest Rates on Deposits
Many Financial Analysts Would Argue That the Added Cost (Not Weighted Average Cost) of Bringing New Funds into the Bank Should Be Used to Price Deposits.
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Market Penetration Deposit Pricing
The Method of Selling Deposits That Usually Sets Low Prices and Fees Initially to Encourage Customers to Open an Account and Then Raises Prices and Fees Later On.
12-22
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Conditional Pricing•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
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Upscale Target Pricing
Bank Aggressively Goes After High-Balance, Low-Activity Accounts. Bank Uses Carefully Designed Advertising to Target Established Business Owners and Managers and Other High Income Households.
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Relationship Pricing
The Bank Prices Deposits According to the Number of Services Purchased or Used. The Customer May Be Granted Lower Fees or Have Some Fees Waived If Two or More Services are Used.
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Basic or Lifeline Banking
Some People Feel That All Individuals Are Entitled to a Minimum Level of Financial Services No Matter Their Income Level
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Quick Quiz• 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?• 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 urn 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?
12-27
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Quick Quiz (cont.)
•Suppose that a customer holds a savings deposit in a savings bank for a year. The balance in the account stood at $2000 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? (Use the formula required by the Truth in Savings Act)
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