CHAPTER 12

Managing And Pricing Deposit Services

This chapter has multiple goals: To learn about the different types of deposits banks and their competitors offer To discover which types of deposits are among the most profitable to offer their customers To explore how an institutions cost of funding can be determined and To examine the different methods open to institutions to price the deposits and deposit-related services they sell to the public.

One of the primary Concerns of Fund Management Strategy is

Liability Management

Goal

Acquire funds at low cost

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Chain Impact
Inadequate Sources or High Cost sources of fund Lack of funds or costly funds available 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 Funds Deposit Services

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Two key issues that every bank/FIs must deal

Where can the bank raise funds at the lowest possible cost?
How can management ensure that the bank always has enough deposits to support the desired volume of loans and other financial services demand by the public?
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Types of Deposits
1. Transaction (Payments/ Demand) Deposits
The transaction, or demand deposit service requires the bank to honor 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 Time deposits generally carry a minimum maturity of days and cannot be withdrawn before that.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 the Offering Institution
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Core Deposits
A Stable Base of Funds that is Not Highly Sensitive to Movements in Market Interest Rates and Which Tend to Remain with the Bank

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Cost Plus Profit Deposit Pricing

Estimating Unit Price Operating Planned Overhead Charged the Expense Profit from Expense Customer = Per Unit of + + Each Allocated to for Each Deposit Service Unit the Deposit Service Service Sold Function

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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 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.
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Upscale Target Pricing

Bank Aggressively Goes After HighBalance, 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. Relationship Banking
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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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CALCULATING COST OF FUND Average Approach =

Interest Cost
Deposit + Non- Deposit Funds

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CALCULATING COST OF FUND Marginal Approach =

Interest Cost
Deposit + Non- Deposit Funds

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