Chapter 12
Content
Chapter Twelve Managing and Pricing Deposit Services
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12-2
Key Topics • Types of Deposit Accounts Offered • The Changing Mix of Deposits and Deposit Costs • Pricing Deposit Services • Conditional Deposit Pricing • Rules for Deposit Insurance Coverage • Disclosure of Deposit Terms • Lifeline Banking McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-3
Introduction • Deposits are a key element in defining what a banking firm really does and what critical roles it really plays in the economy • Moreover, deposits provide much of the raw material for making loans and, thus, may represent the ultimate source of profits and growth for a depository institution • Two key issues every depository institution must deal with in managing the public’s deposits ▫ ▫
Where can funds be raised at lowest possible cost? How can management ensure that the institution always has enough deposits to support lending and other services the public demands?
• So challenging has it become today to attract significant new deposits that many financial firms have created a new executive position – chief deposit officer McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-4
Types of Deposits Offered by Depository Institutions • Transaction (Payment or Demand) Deposits ▫ ▫ ▫ ▫
Making payment on behalf of customers One of the oldest services Provider is required to honor any withdrawals immediately Hottest item in the transaction deposit field today appears to be the mobile check deposit ▫ Designed principally for customers on the move, carrying camera-equipped smart phones
• Nontransaction (Savings or Thrift) Deposits ▫ Longer-Term ▫ Higher Interest Rates Than Transaction Deposits ▫ Generally Less Costly to Process and Manage McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-5
Types of Deposits Offered by Depository Institutions (continued) • Transaction Deposit ▫ An account used primarily to make payments for purchases of goods and services
• 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) ▫ Money Market Deposit Account (MMDA) and Super NOW due to Garn-St Germain Depository Institution Act of 1982 McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-6
Types of Deposits Offered by Depository Institutions (continued) • Nontransaction Deposit ▫ An account whose primary purpose is to encourage the bank customer to save rather than make payments
• Types of Nontransaction Deposits ▫ ▫ ▫ ▫
Passbook Savings Account Statement Savings Deposit Time Deposit (CD) Retirement Savings Deposits ▫ Individual Retirement Account (IRA) - The Economic Recovery Tax Act of 1981 ▫ Keogh Plan retirement accounts – available to self-employed persons ▫ Roth IRA – The Tax Relief Act of 1997 allows non-tax-deductible contributions that can grow tax free and pay no tax on investment earnings when withdrawn ▫ Default Option Retirement Plans – The Pension Protection Act of 2006
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-7
Interest Rates Offered on Different Types of Deposits • The Composition of Deposits ▫ Bankers would generally prefer a high proportion of transaction deposits (including regular checking or demand accounts) and lowyielding time and savings deposits ▫ These accounts are among the least expensive of all sources of funds and often include a substantial percentage of core deposits
• The Ownership of Deposits ▫ The dominant holder of bank deposits inside the United States is the private sector
• The Cost of Different Deposit Accounts ▫ Managers of depository institutions would prefer to sell only the cheapest deposits to the public but it is predominantly public preference that determines which types of deposits will be created
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-8
TABLE 12–1 The Changing Composition of Deposits in the United States
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-9
Pricing Deposit-Related Services • In pricing deposit services, management is caught in a dilemma ▫ It needs to pay a high enough interest return to attract and hold customer funds, but must avoid paying an interest rate so costly it erodes any potential profit margin
• An individual depository institution has little control over its prices in a financial marketplace that approaches perfect competition ▫ It is the marketplace, not the individual financial firm, that ultimately sets prices ▫ Financial institutions, like most other businesses, are price takers, not price makers McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-10
Pricing Deposits at Cost Plus Profit Margin • The Glass-Steagall Act of 1933 – Federal limits on interest rates paid on deposits ▫ The Depository Institutions Deregulation Act of 1980
• Deregulation has brought more frequent use of unbundled service pricing as greater competition has raised the average real cost of a deposit for deposit-service providers • This means that deposits are usually priced separately from other services ▫ Cost-plus pricing formula
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-11
Using Marginal Cost to Set Interest Rates on Deposits • What deposit interest rate should the bank offer its customers? ▫ We need to know ▫ The marginal cost of moving the deposit rate from one level to another ▫ The marginal cost rate, expressed as a percentage of the volume of additional funds coming into the bank
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-12
TABLE 12–2 Using Marginal Cost to Choose the Interest Rate to Offer Customers on Deposits
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-13
Using Marginal Cost to Set Interest Rates on Deposits • Conditional Pricing ▫ Where a depository sets up a schedule of fees in which the customer pays a low fee or no fee if the deposit balance remains above some minimum level, but faces a higher fee if the average balance falls below that minimum ▫ Conditional pricing techniques vary deposit prices based on one or more of these factors 1.
2. 3.
The number of transactions passing through the account (e.g., number of checks written, deposits made, wire transfers, stoppayment orders, or notices of insufficient funds issued) The average balance held in the account over a designated period (usually per month) The maturity of the deposit in days, weeks, months, or years
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-14
EXHIBIT 12–1 Example of the Use of Conditional Deposit Pricing by Two Banks Serving the Same Market Area
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-15
Using Marginal Cost to Set Interest Rates on Deposits • Conditional Pricing ▫ Deposit pricing policy is sensitive to at least two factors: 1. 2.
The types of customers each depository institution plans to serve The cost that serving different types of depositors will present to the offering institution
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-16
Pricing Based on the Total Customer Relationship and Choosing a Depository • Related to the idea of targeting the best customers for special treatment is the notion of pricing deposits according to the number of services the customer uses ▫ Customers who purchase two or more services may be granted lower deposit fees compared to the fees charged customers having only a limited relationship to the offering institution
• In theory, relationship pricing promotes greater customer loyalty and makes the customer less sensitive to the prices posted on services offered by competing financial firms
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-17
TABLE 12–3 Factors in Household and Business Customers’ Choice of a Financial Firm for Their Deposit Accounts (ranked from most important to least important)
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-18
Basic (Lifeline) Banking: Key Services for Low-Income Customers • Should every adult citizen be guaranteed access to certain basic financial services, such as a checking account or personal loan? • A recent survey found that a substantial segment of the U.S. population is either ▫ “Unbanked” ▫ No deposits or loans of any kind
▫ “Underbanked” ▫ Having access to some critical services but not others
• Among the “underbanked” are those families relying on expensive payday loans, check cashing firms, pawnshops, and money order services to pay their bills • Racial and ethnic minorities are substantially more likely than the general population to be “underbanked” McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-19
Truth in Savings Act • Passed in November 1991 • 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 The APY
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-20
Quick Quiz • What are the major types of deposit plans that depository institutions offer today? • What are core deposits, and why are they so important today? • How has the composition of deposits changed in recent years? • Describe the essential differences between the following deposit pricing methods in use today: cost-plus pricing, conditional pricing, and relationship pricing. • What factors do household depositors rank most highly in choosing a financial firm for their checking account? Their savings account? What about business firms? • What does the 1991 Truth in Savings Act require financial firms selling deposits inside the United States to tell their customers? • What is lifeline banking? What pressures does it impose on the managers of banks and other financial institutions? McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-2
Key Topics • Types of Deposit Accounts Offered • The Changing Mix of Deposits and Deposit Costs • Pricing Deposit Services • Conditional Deposit Pricing • Rules for Deposit Insurance Coverage • Disclosure of Deposit Terms • Lifeline Banking McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-3
Introduction • Deposits are a key element in defining what a banking firm really does and what critical roles it really plays in the economy • Moreover, deposits provide much of the raw material for making loans and, thus, may represent the ultimate source of profits and growth for a depository institution • Two key issues every depository institution must deal with in managing the public’s deposits ▫ ▫
Where can funds be raised at lowest possible cost? How can management ensure that the institution always has enough deposits to support lending and other services the public demands?
• So challenging has it become today to attract significant new deposits that many financial firms have created a new executive position – chief deposit officer McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-4
Types of Deposits Offered by Depository Institutions • Transaction (Payment or Demand) Deposits ▫ ▫ ▫ ▫
Making payment on behalf of customers One of the oldest services Provider is required to honor any withdrawals immediately Hottest item in the transaction deposit field today appears to be the mobile check deposit ▫ Designed principally for customers on the move, carrying camera-equipped smart phones
• Nontransaction (Savings or Thrift) Deposits ▫ Longer-Term ▫ Higher Interest Rates Than Transaction Deposits ▫ Generally Less Costly to Process and Manage McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-5
Types of Deposits Offered by Depository Institutions (continued) • Transaction Deposit ▫ An account used primarily to make payments for purchases of goods and services
• 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) ▫ Money Market Deposit Account (MMDA) and Super NOW due to Garn-St Germain Depository Institution Act of 1982 McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-6
Types of Deposits Offered by Depository Institutions (continued) • Nontransaction Deposit ▫ An account whose primary purpose is to encourage the bank customer to save rather than make payments
• Types of Nontransaction Deposits ▫ ▫ ▫ ▫
Passbook Savings Account Statement Savings Deposit Time Deposit (CD) Retirement Savings Deposits ▫ Individual Retirement Account (IRA) - The Economic Recovery Tax Act of 1981 ▫ Keogh Plan retirement accounts – available to self-employed persons ▫ Roth IRA – The Tax Relief Act of 1997 allows non-tax-deductible contributions that can grow tax free and pay no tax on investment earnings when withdrawn ▫ Default Option Retirement Plans – The Pension Protection Act of 2006
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-7
Interest Rates Offered on Different Types of Deposits • The Composition of Deposits ▫ Bankers would generally prefer a high proportion of transaction deposits (including regular checking or demand accounts) and lowyielding time and savings deposits ▫ These accounts are among the least expensive of all sources of funds and often include a substantial percentage of core deposits
• The Ownership of Deposits ▫ The dominant holder of bank deposits inside the United States is the private sector
• The Cost of Different Deposit Accounts ▫ Managers of depository institutions would prefer to sell only the cheapest deposits to the public but it is predominantly public preference that determines which types of deposits will be created
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-8
TABLE 12–1 The Changing Composition of Deposits in the United States
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-9
Pricing Deposit-Related Services • In pricing deposit services, management is caught in a dilemma ▫ It needs to pay a high enough interest return to attract and hold customer funds, but must avoid paying an interest rate so costly it erodes any potential profit margin
• An individual depository institution has little control over its prices in a financial marketplace that approaches perfect competition ▫ It is the marketplace, not the individual financial firm, that ultimately sets prices ▫ Financial institutions, like most other businesses, are price takers, not price makers McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-10
Pricing Deposits at Cost Plus Profit Margin • The Glass-Steagall Act of 1933 – Federal limits on interest rates paid on deposits ▫ The Depository Institutions Deregulation Act of 1980
• Deregulation has brought more frequent use of unbundled service pricing as greater competition has raised the average real cost of a deposit for deposit-service providers • This means that deposits are usually priced separately from other services ▫ Cost-plus pricing formula
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-11
Using Marginal Cost to Set Interest Rates on Deposits • What deposit interest rate should the bank offer its customers? ▫ We need to know ▫ The marginal cost of moving the deposit rate from one level to another ▫ The marginal cost rate, expressed as a percentage of the volume of additional funds coming into the bank
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-12
TABLE 12–2 Using Marginal Cost to Choose the Interest Rate to Offer Customers on Deposits
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-13
Using Marginal Cost to Set Interest Rates on Deposits • Conditional Pricing ▫ Where a depository sets up a schedule of fees in which the customer pays a low fee or no fee if the deposit balance remains above some minimum level, but faces a higher fee if the average balance falls below that minimum ▫ Conditional pricing techniques vary deposit prices based on one or more of these factors 1.
2. 3.
The number of transactions passing through the account (e.g., number of checks written, deposits made, wire transfers, stoppayment orders, or notices of insufficient funds issued) The average balance held in the account over a designated period (usually per month) The maturity of the deposit in days, weeks, months, or years
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-14
EXHIBIT 12–1 Example of the Use of Conditional Deposit Pricing by Two Banks Serving the Same Market Area
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-15
Using Marginal Cost to Set Interest Rates on Deposits • Conditional Pricing ▫ Deposit pricing policy is sensitive to at least two factors: 1. 2.
The types of customers each depository institution plans to serve The cost that serving different types of depositors will present to the offering institution
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-16
Pricing Based on the Total Customer Relationship and Choosing a Depository • Related to the idea of targeting the best customers for special treatment is the notion of pricing deposits according to the number of services the customer uses ▫ Customers who purchase two or more services may be granted lower deposit fees compared to the fees charged customers having only a limited relationship to the offering institution
• In theory, relationship pricing promotes greater customer loyalty and makes the customer less sensitive to the prices posted on services offered by competing financial firms
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-17
TABLE 12–3 Factors in Household and Business Customers’ Choice of a Financial Firm for Their Deposit Accounts (ranked from most important to least important)
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-18
Basic (Lifeline) Banking: Key Services for Low-Income Customers • Should every adult citizen be guaranteed access to certain basic financial services, such as a checking account or personal loan? • A recent survey found that a substantial segment of the U.S. population is either ▫ “Unbanked” ▫ No deposits or loans of any kind
▫ “Underbanked” ▫ Having access to some critical services but not others
• Among the “underbanked” are those families relying on expensive payday loans, check cashing firms, pawnshops, and money order services to pay their bills • Racial and ethnic minorities are substantially more likely than the general population to be “underbanked” McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-19
Truth in Savings Act • Passed in November 1991 • 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 The APY
McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
12-20
Quick Quiz • What are the major types of deposit plans that depository institutions offer today? • What are core deposits, and why are they so important today? • How has the composition of deposits changed in recent years? • Describe the essential differences between the following deposit pricing methods in use today: cost-plus pricing, conditional pricing, and relationship pricing. • What factors do household depositors rank most highly in choosing a financial firm for their checking account? Their savings account? What about business firms? • What does the 1991 Truth in Savings Act require financial firms selling deposits inside the United States to tell their customers? • What is lifeline banking? What pressures does it impose on the managers of banks and other financial institutions? McGraw-Hill/Irwin Bank Management and Financial
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
