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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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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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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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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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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maturity of days and cannot be withdrawn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