Chapter Ten Managing and Pricing Deposit Services
Key Topics • Types of Deposit Accounts Offered • The Changing Mix of Deposits and Deposit Costs • Pricing Deposit Services • Conditional Deposit Pricing • Disclosure of Deposit Terms • Lifeline Banking
Introduction p. 293 • Deposits are a key element in defining what a bank does and what critical roles it plays in the economy • Deposits provide mostof the money for making loans and represent the primary source of profits and growth for a bank.
Introduction (continued) p. 294 • Two key issues every bank must deal with in managing the public’s deposits • Where can funds be raised at the lowest cost? • How can management be sure that the bank always has enough deposits to provide loans and other services people demand? • So challenging has it become today to get large, new deposits that many banks have created a new leadership position – chief deposit officer
Types of Deposits Offered by Banks p. 294 1. Transaction 交易 (jiāoyì) (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
Types of Deposits Offered by Banks p. 294 2. Nontransaction(Savings) Deposits • Longer-Term • Higher Interest Rates Than Transaction Deposits • Generally Less Costly to Process and Manage
Types of Deposits Offered by Banks (continued) p. 294-295 Transaction Deposit • An account used primarily to make payments for purchases of goods and services 1. Types of Transaction Deposits A. Noninterest-Bearing Demand Deposits • Interest was prohibited by Glass-SteagallAct. Too costly to banks. • One of the most volatile and unpredictable sources of funds • Most deposits are held by business firms
Types of Deposits Offered by Banks (continued) p. 294-295 B. Interest-Bearing Demand Deposits • Negotiable Orders of Withdrawal (NOW) – like a checking and savings in one account. It pays some interest but customers must give notice before withdrawing funds. • Money Market Deposit Account (MMDA) and Super NOW due to Garn-St Germain Depository Institution Act of 1982. Pay higher interest rates backed by low risk securities, bonds.
Types of Deposits Offered by Banks (continued) p. 296-297 • Nontransaction Deposit • An account whose primary purpose is to encourage the bank customer to save rather than make payments 2. Types of Nontransaction Deposits A. Passbook Savings Account – small deposits, less limits on withdrawels. Used savings book. B. Statement Savings Deposit – e-statements C. Time Deposit (CD) – purchased for as few as 7 days and up to 5 years.
Types of Deposits Offered by Banks (continued) p. 296-297 D. Retirement Savings Deposits • Individual Retirement Account (IRA) – Save for retirement, tax deduction • 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
Interest Rates Offered on Different Types of Deposits p. 297-298 • The Composition 组成 (zǔchéng) of Deposits • Bankers would generally prefer a high proportion of transaction deposits (including regular checking or demand accounts) and low-yielding time and savings deposits • These accounts are among the least expensive of all sources of funds and often include a substantial percentage of CORE 核心 (héxīn) DEPOSITS
Interest Rates Offered on Different Types of Deposits p. 297-298 • 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 banks would prefer to sell only the cheapest deposits to the public but it is public preference that determines which types of deposits will be created
TABLE 10–1 The Changing Composition of Deposits in the United States p. 298
Pricing Deposit-Related Services p. 302 • In pricing deposit services, management is caught in a dilemma 困境 (kùnjìng) • 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 takes away from profit margin
Pricing Deposit-Related Services p. 302 • An individual depository institution has little control over its prices in a financial marketplace that approaches perfect competition • It is the marketplace, consumers like you and me (the public), not the individual financial firm, that ultimately sets prices • Financial institutions, like most other businesses, are price takers, not price makers
Pricing Deposits at Cost Plus Profit Margin p. 302-304 • 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 single (unbundled) service pricing as greater competition has raised the average real cost of a deposit for deposit-service providers.
Pricing Deposits at Cost Plus Profit Margin p. 302-304 • This means that deposits are usually priced separately from other services • Cost-plus pricing formula
Using Marginal Cost to Set Interest Rates on Deposits p. 305-306 • 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
TABLE 12–2 Using Marginal Cost to Choose the Interest Rate to Offer Customers on Deposits p. 305
Using Marginal Cost to Set Interest Rates on Deposits p. 306-309 • Conditional 有条件的 (yǒutiáojiàn de) Pricing • Where a bank 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
Using Marginal Cost to Set Interest Rates on Deposits p. 306-309 • Conditional Pricing • Conditional pricing techniques vary deposit prices based on one or more of these factors • The number of transactions passing through the account (e.g., number of checks written, deposits made, wire transfers, stop-payment 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
Using Marginal Cost to Set Interest Rates on Deposits • Conditional Pricing • Deposit pricing policy is sensitive to at least two factors: • The types of customers each bank plans to serve • The cost that serving different types of depositors will present to the bank
EXHIBIT 10–1 Example of the Use of Conditional Deposit Pricing by Two Banks Serving the Same Market Area p. 309
Truth in Savings Act p. 307 • 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
Pricing Based on the Total Customer Relationship(Pricing) and Choosing a Depository p. 310 • Related to the idea of targeting the best customers for special treatment is the idea 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
TABLE 10–3 Factors in Household and Business Customers’ Choice of a Financial Firm for Their Deposit Accounts (ranked from most important to least important) p. 310
Basic (Lifeline) Banking: Key Services for Low-Income Customers p. 312-313 • 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
Basic (Lifeline) Banking: Key Services for Low-Income Customers p. 312-313 • 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 more likely than the general population to be “underbanked”
Quick Quiz – Concept Check Q and A 1. What are the major types of deposit plans that depository institutions offer today? A: Deposit plans can be divided broadly into transaction deposits, thrift or nontransaction deposits, and retirement savings deposits. The primary function of transaction deposits is to make immediate payments to the customers. The principal function of thrift deposits is to serve as savings accounts and pay higher interest rates than transaction deposits do. Thrift deposits include passbook and statement savings accounts, certificates of deposits (CDs), and other time deposit accounts. Retirement savings deposits are an instrument especially for saving for the future. 2. What are core deposits, and why are they so important today? A: Core deposits are the most stable parts of a banks funding base and usually include smaller savings accounts. They are characterized by relatively low interest-rates. Holding a large amount of core deposits has an advantage in having access to a stable and cheaper source of funding with a relatively low interest-rate risk.
Quick Quiz – Concept Check Q and A 3. Describe the essential differences between the following deposit pricing methods in use today: cost-plus pricing, conditional pricing, and relationship pricing. A: Cost-plus deposit pricing calls for a bank to charge deposit service fees adequate to cover all the costs of offering the service plus a small margin for profit. Conditional pricing is used today as a tool by banks to attract the kinds of depositors they want to have as customers. With this pricing technique a bank will post a schedule of offered interest rates or fees assessed based on account activity. This type of pricing encouraged customers to hold a high average deposit balance which gives the bank more funds to invest in earning assets. Relationship pricing involves basing fees charged to a customer on the number of services the customer purchases from a bank. Many services means a lower fee or no fee.
Quick Quiz – Concept Check Q and A 4. What does the 1991 Truth in Savings Act require financial firms selling deposits inside the United States to tell their customers? A: The 1991 Truth in Savings Act requires banks to fully inform their deposit customers on the terms offered to each depositor. The customer must be informed about any penalties or service fees which could reduce his or her expected yield. If the terms of a deposit are changed in a way that would reduce the depositor's return, advance notice must be given to the account holder. • 5. What is lifeline banking? What pressures does it impose on the managers of banks and other financial institutions? A: Lifeline banking refers to basic service packages offered by banks to poorer customers not able to afford conventional bank service offerings. Banks are helped by government in the form of low-interest loans and deposit insurance and, therefore, have some public-service responsibilities which may include providing certain basic services to all potential customers, regardless of their income or social status