Chapter 13 Managing and Pricing Deposit Services: The ability of management and staff to attract checking and savings

deposits from businesses and consumers is an important measure of a depository institutions acceptance by the public Raw material for loans. Lowest possible cost, sufficient funds.

1. Where can the funds be raised at the lowest possible cost? 2. How can management ensure that the institution always has enough deposits to support the volume of loans and other investments and services the public demands? Types of Deposits: Transactions deposits: Making payments on behalf of the customer. 1. Noninterest bearing demand deposits: 2. Interest bearing demand deposits: at least some interest: NOWs. Bank has the right to insist on prior notice. Individuals and nonprofit organizations only. MMDAs and Super NOWs , offering flexible money market interest rates but accessible via check or preauthorized draft to pay for goods and services. Nontransactions deposits: Savings deposits or thrift deposits, are designed to attract funds from customers who wish to set aside money in anticipation of future expenditures or financial emergencies. Higher interest costs. Passbook savings deposits were sold to households in small denominations with unlimited withdrawal privileges. Prior notice required but not exercised. Rate stable with little sensitivity to interest rates.

Time deposits for wealthier individuals and businesses. Fixed maturity and fixed interest rates. Many forms such as the negotiable CD, non-negotiable.

Interest rates offered on differet types of deposits: Longer term higher rates. Size and perceived risk exposure of offering institutions. Larger and stronger banks, generally lowest average interest rates, others upward from there. Choose to compete aggressively for funds or not. Contrast: discourage post lower rates. The composition of bank deposits: Table 13.1 Time and savings deposits 4/5ths of total deposits. Demand less than 1/5th. Value of checks paid in the U.S fell from $49 billion in 1995 to 42 billion in 2000. Bankers prefer high proportion of transactions deposits and low-yielding time and savings deposits. Why? Least expensive and often include CORE DEPOSITS CORE DEPOSITS: low interest rate elasticity and remain with bank. Duration of banks liabitlities increases makes institution less vulnerable to changing interest rates. Bank operating costs in offering deposit services have soared recently. 10.5 billion in 1970 to 80 billion in 2002.new high yielding deposits vs. older less expensive ones have put pressure. Institutions that couldnt keep up extra liquidity demands. Bankers pushing hard to reduce noninterst expenses therefore. Table 11.2

The functional cost analysis of different deposit accounts: If a bank can raise all of its capital from sales of the cheapest deposits and then turn them around and purchase the highest yielding assets- this would maximize its spread and possibly net income. So, What are the cheapest deposits? And which deposits generate the highest revenues? Demand deposits. Check processing and account maintenance costs only. These will also come down in future because of check imaging. Money market accounts , time deposits and savings accounts rank second, mainly savings accounts. Although checking accounts have same gross expenses per dollar as time deposits do, they have higher service fees. Activity expenses: processing checks and recording deposits. Conclusion: Public preference. Pricing deposit related Services: Old dilemma Competition Perfect competition Cost Plus Profit Margin: Idea of charging customers for full cost of deposit-related services is relatively new. Development of interest bearing checkable deposit, particularly NOWs , triggered this idea. Below-cost pricing before this, whose rate of return was higher called the implicit rate of interest. Great depression to the 1980s.

Then it was time for private decision makers. Greater competition because of deregulation has raised average real cost of deposit for bankers COST PLUS PRICING FORMULA: Unit price charged to the customer for each deposit service= Operating expense per unit of deposit service + Estimated overhead expense allocated to the deposit service function + Planned profit for each deposit service unit sold

Result free services eliminated: fees for excessive withdrawals, charges for balance inquiries, increasing fees on bounced checks, stop-payment orders, assessing charges on cash withdrawals and balance inquiries through ATMs, monthly maintenance fees, raising minimum deposit balances.