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CHAPTER 12
Managing And Pricing DepositServices
This chapter has multiple goals:
To learn about the different types of deposits banksand their competitors offerTo discover which types of deposits are among themost profitable to offer their customersTo explore how an institutions cost of funding can bedetermined and
To examine the different methods open to institutionsto price the deposits and deposit-related services theysell to the public.
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Bank Management and Financial Services, 6/e 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
One of the primary Concerns of Fund
Management Strategy is
Acquire funds at low cost
Liability Management
Goal
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Chain Impact
Inadequate Sources orHigh Cost sources of fund
Lack of funds or costly fundsavailable for lending
Low volume of assets and
low margin
Low level of Profit
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Bank Management and Financial Services, 6/e 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Broad Sources of Funds
Deposit
Borrowing
Bank Capital
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Managing Sources of
FundsDeposit Services
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Two key issues that everybank/FIs must deal
Where can the bank raise funds atthe lowest possible cost?
How can management ensure thatthe bank always has enough
deposits to support the desiredvolume of loans and other financialservices demand by the public?
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Bank Management and Financial Services, 6/e 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Types of Deposits
1. Transaction (Payments/ Demand) DepositsThe transaction, or demanddeposit service requires the bank tohonor immediately any withdrawals made
I. Non-interest bearing demand deposit
Pays no explicit interest
Provide payment, safekeeping, drawing checks
II. Interest bearing demand deposit
Bank may require prior notice before withdrawal
Pay some interest
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Bank Management and Financial Services, 6/e 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Types of Deposits
2. Non transaction Deposits: Time Deposits
Time deposits carry fixed maturity dates
(usually covering 30, 60, 90, or 180 days)with fixed interest rates.
Time deposits generally carry a minimum
maturity of days and cannot be withdrawn
before that.
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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 theOffering Institution
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Core Deposits
A Stable Base of Funds that is Not Highly
Sensitive to Movements in Market InterestRates and Which Tend to Remain with the
Bank
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Cost Plus Profit Deposit Pricing
Unit PriceCharged the
Customer
for Each
Service
=
OperatingExpense
Per Unit of
Deposit
Service
+
Estimating
Overhead
Expense
Allocated to
the Deposit
Function
+
PlannedProfit from
Each
Service Unit
Sold
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Historical Average Cost Approach
Determines the Banks Cost 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 Banks Cost of Funds by
Looking at the Future.
What minimum Rate of Return is the BankGoing 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 WeightedAverage Cost) of Bringing New Funds into
the Bank Should Be Used to Price
Deposits.
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Upscale Target Pricing
Bank Aggressively Goes After High-
Balance, Low-Activity Accounts.
Bank Uses Carefully DesignedAdvertising 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.
Relationship Banking
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Basic or Lifeline Banking
Some People Feel That All Individuals Are
Entitled to a Minimum Level of FinancialServices No Matter Their Income Level
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CALCULATING COST OF FUND
Average Approach =
Interest Cost
Deposit + Non- DepositFunds
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CALCULATING COST OF FUND
Marginal Approach =
Interest Cost
Deposit + Non- Deposit
Funds