Chapter Twelve

Managing and Pricing Deposit Services

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 Key Topics

• Types of Deposit Accounts Offered

• Changing Mix of Deposits and Deposit Costs
• Pricing Deposit Services
• Conditional Deposit Pricing
• Lifeline Banking

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 Introduction
• Deposits are a key element of banking and what
critical roles it in the economy

• Deposits are raw material for making loans,

• Represent the ultimate source of profits and growth for

a bank

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 Introduction
• Two key issues every bank deal with in managing the
public’s deposits
1. Where can funds be raised at lowest possible cost?
2. How can management ensure that the bank always has
enough deposits to support lending and other services

• So challenging has it become today to attract significant

new deposits that many banks have created a new
executive position – chief deposit officer

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 Types of Deposits Offered by Banks
• Transaction Deposits
▫ Making payment on behalf of customers
▫ One of the oldest services
▫ Required to honor any withdrawals immediately

• Non-transaction Deposits
▫ Longer-Term
▫ Higher Interest Rates than Transaction Deposits
▫ Less Costly to Process and Manage

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 Types of Deposits Offered by Banks
• Transaction Deposit
▫ For making 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

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 Types of Deposits Offered by Banks
• 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 (USA)
▫ Individual Retirement Account (IRA) –
▫ Keogh Plan retirement accounts – available to self-employed persons
▫ Roth IRA – The Tax Relief Act of 1997 Default Option Retirement
Plans – The Pension Protection Act of 2006
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 Interest Rates on Different Types of Deposits
• The Composition of Deposits
▫ Bankers prefer a high proportion of transaction deposits 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 deposits
• The Ownership of Deposits
▫ The dominant holder of bank deposits is the private sector
• The Cost of Different Deposit Accounts
▫ Bank managers 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
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 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

• A bank has little control over its prices in a financial

marketplace that approaches perfect competition
▫ It is the marketplace, not the individual bank that ultimately sets
prices
▫ Banks, like other businesses, are price takers, not price makers
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 Pricing Deposits at Cost Plus Profit Margin
• Deposits are usually priced separately from other services

▫ Cost-plus pricing formula

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 Using Marginal Cost to Set Interest Rates
• What deposit interest rate the bank offer?
▫ 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

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 TABLE 12–2 Using Marginal Cost to Choose the Interest
Rate to Offer Customers on Deposits

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 Using Marginal Cost to Set Interest Rates
• Conditional Pricing

▫ 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
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 Using Marginal Cost to Set Interest Rates

• Conditional Pricing
▫ Techniques vary deposit prices based on one or
more of these factors
1. 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)
2. The average balance held in the account per month
3. The maturity of the deposit in days, weeks, months,
or years
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 EXHIBIT 12–1 Example of the Use of Conditional Deposit
Pricing by Two Banks Serving the Same Market Area

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 Using Marginal Cost to Set Interest Rates

• Conditional Pricing

▫ Deposit pricing policy is sensitive to at least two

factors:

1. The types of customers each bank plans to serve

2. The cost that serving different types of depositors

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 Total Customer Relationship Pricing
• Targeting the best customers for special treatment based
on the number of services the customer uses
▫ Customers who use two or more services may be granted
lower deposit fees
▫ compared to those customers having only a limited
relationship to the bank

• In theory, relationship pricing

• promotes greater customer loyalty and
• makes the customer less sensitive to the prices posted on
services offered by competing banks

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 TABLE 12–3 Factors in Household and Business Customers’
Choice of a Bank for Their Deposit Accounts (ranked from most
important to least important)

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 Basic Banking

• Lifeline Banking: Key Services for Low-Income Customers

• Every adult citizen be guaranteed access to certain basic
banking 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

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 Basic Banking

• The “underbanked” are those families relying on

• expensive payday loans,
• check cashing firms,
• pawnshops, and
• money order services to pay their bills

• Ethnic minorities are more likely than the general

population to be “underbanked”

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