Background note for Coolidge Bank Case

Sources of funds for a bank:

 Capital
 Deposits
 Non-Deposit Sources

[In the context of banks, the expression ‘liabilities’, refers to outside

liabilities. Unlike other businesses, banks are highly leveraged
institutions ie the major part of their business is financed or done using
borrowed funds or funds deposited with them by their customers or
depositors.]

Liabilities products offered by banks develop over a period of time in response to

regulations, restrictions and market demand. As with any product, marketing liability
products would, among other things, involve “product design and product
differentiation” and “product pricing”. The liabilities marketing strategy of each
bank is a function of the bank’s overall business strategy and its own strengths based
on factors like presence across different geographies and income classes. For
example, Small Finance Banks that have recently (2016) been given a banking license
by the Reserve Bank of India (licensing authority for banks in India), would typically
try to develop products that cater to the needs of small depositors such as recurring
deposits or deposits in which small sums can be accumulated on a regular basis.

Deposits:

Deposits form the major and core source of resources of banks. Banks are
described ‘highly-leveraged’ institutions because capital constitutes a small portion of
their funds. Banks accept different types of deposits. They can broadly be classified
as:
 Demand Deposits
 Term or Fixed Deposits
 Savings Bank Deposits
In the USA, banks offer Checking Deposits, Term Deposits and negotiable Certificate
of Deposits; they do not have the equivalent of our “Savings Bank Account”

Current Accounts or Checking accounts (Demand Deposits):

 Product - “The Current Account” :

o Unlimited checking facilities (unlimited issue of checks).
o No interest is paid on these accounts (regulations).
o Either a minimum balance to be maintained or no minimum balance
requirements
o A fee charged for every transactions if there is no minimum balance
requirement. In case of a minimum balance requirement, specified
number of free transactions are allowed
o No restrictions on the amount that can be withdrawn without notice.
o Generally used by corporates & HNI’s.
 o For the bank the total funds in these accounts is highly unpredictable.

 The name says it all! These are deposits that are withdrawable on demand ie at
any point of time on the customers’ demand.
 Used by those who have large payments and receipts. – financial transactions
 The normal mode of withdrawal used to be through issue of cheques and
hence these are also called the “checking accounts” in many countries.
 In most countries including India, no interest can be paid on these deposits.
RBI has prohibited payment of interest upto 7 days
 On the other hand, banks generally charge for the service rendered:
Transaction costs or charges per transaction
o Transaction charges could be different for cash, clearing & online
transactions (Explicit Pricing)
o Cost of transactions could be recovered by banks through the
requirement of a “minimum balance” to be maintained (“Implicit
Pricing”)
 Banks are assured of a minimum balance in CASA accounts
 Banks lend this amount and earn interest income
 Current accounts are generally used by businesses, corporates etc. But they
are also used by high net-worth individuals who might need to issue a large
number of cheques, frequently.
 Balances in these accounts fluctuate a great deal; in other words, the balances
are highly volatile. Thus banks are, typically, very cautious in using these
deposits to fund assets. However, with careful planning and strategizing, they
can become a source of cheap funds. How?
o To start with, banks study the past trend in withdrawals from these
accounts to determine the quantum of “core deposits” or the amount of
deposits that, despite being withdrawable on demand, is in fact, not
withdrawn by customers and remains with the bank
o This amount can then be used to fund assets and since these are zero
cost funds, are the cheapest source of funds for banks.

Savings Deposits:

 Product - “Savings Account” or “Savings Bank (SB) Account” :

o In India , banks pay interest on the balances in these accounts.
o Interest on daily balances (as per RBI regulations)
o Limited checking facilities
o A minimum balance as specified by the bank, has to be maintained.
o Many banks have some restrictions on the amount that can be
withdrawn without notice.
o In India such accounts can be opened by individuals, Hindu Undivided
Families (HUF) and by clubs/ associations. Not by commercial firms /
corporates.
o Combination of a facility for financial transactions & and some
earnings
o Fairly stable volumes
 These are deposits that are like current account deposits but with restrictions
on the number of withdrawals that can be made.
  A mix of the features of the “checking deposits” and the term deposits
 Basically evolved as deposits for keeping the savings of individuals

Term / Fixed Deposits

 Product: “Fixed Deposit or FD”

 Deposits are accepted by banks for fixed term.
 Generally deposits for one or above are categorized as fixed
deposits.
 Others are referred to as Short term Deposits.
 The interest rate is decided by the banks.
 Stable volumes
 Very popular with retail segment 52% of total liabilities & 65% of total
deposits
 Since the term is fixed, the principal is required to be paid only on the due date
or maturity date. However, in India “Pre Mature” repayment has to be offered
to all depositors

Negotiable Certificates of Deposits (CD’s)

 Certificate of Deposit is Negotiable Promissory Note of a Bank.
 There exists a secondary market for this instrument.
 Since it is negotiable, it has high liquidity
 This instrument is very popular in the West.
 Generally issued with not more than one year maturity

Pricing of Liabilities
 Implicit Pricing
o A bundle of “free” services are provided. Banks insist on a certain
“minimum” balance to cover these costs
 Explicit Pricing
o The services provided are unbundled and each priced separately to
reflect the actual cost to the bank
o Business may prefer such explicit pricing as charges paid for services
would be “expenses” and therefore provide a tax-shield
o Retail customers’ preferences may change over time. Generally when
the interest rates are low, customers are not sensitive to rates; implicit
pricing would work better.
o Understanding customers preferences therefore is very important
 Pricing Policy
o It is generally a strategy which takes into account
 Interest elasticity of deposits
 Past trends of deposits
 Over-all deposit mix
 Implicit vs explicit pricing
 Customer relationship pricing
 Competitor’s strategy
 Impact of cost of funds on profits
 Promotional pricing of new products
 Product differentiation