Managing and pricing deposit services

1. Chapter 13 Managing and pricing deposit services

2. Deposits are the foundation upon which banks thrive and grow • The ability of a bank’s management and staff to attract checking and savings accounts from businesses and consumers is an important measure of the bank’s acceptance by the public. • Raw material • Management’s efficiency can be measured by whether or not deposited funds have been raised at the lowest possible cost and whether enough deposits are available to fund those loans the bank wishes to make.

3. Two major questions bank management is always trying to answer are: • 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 demanded by the public? • Innovation, is the form of new deposit plans, service delivery methods and pricing schemes, is extensive in banking today.

4. Types of Deposits Offered by the Banks • Transaction (payments) Deposit: an account used primarily to make payments for purchases of goods and services. • Noninterest-bearing Demand Deposits • Interest-bearing Demand Deposits (Negotiable order of withdrawal NOW accounts) • Money market deposit accounts • Supper NOWs

5. Non transaction (Saving or Thrift) Deposits • Thrift deposit • Passbook savings deposits • Time deposit

6. Composition of Bank Deposits • Core Deposits: Among the most loyal and stable of a bank’s deposited funds normally owned by households and small businesses

7. Pricing Deposits at Cost Plus Profit Margin • Pricing of the deposits are very important as the banks should know how much they are paying to buy the raw material. • Cost-plus-profit deposit pricing: • Establishing the rate of return or fees charged on a deposit account based upon the cost of offering the service plus a profit margin.

8. Unit price charged the customer for each deposit service Estimated overhead expense allocated to the bank’s deposit function Operating expense per unit of deposit service Planned profit from each deposit service unit sold

9. Estimating Average Deposit Service Costs • Bankers are required • to calculate cost rate of each source of bank funds (adjusted for reserves required by the central bank, deposit insurance fees and float) • to multiply each cost rate by relative proportion of bank funds coming from that particular source • To sum all resulting products to derive the weighted average cost of the bank funds

10. Data for Question

11. Weighted Average (checkbook deposits /total funds raised) x (interest and noninterest fund-raising cost/ 100%-percentage reserve requirements and float) + (time and saving deposits / total funds raised) x (interest and noninterest fund- raising costs/ 100% - percentage reserve requirements and float) + (owner’s capital / total funds raised) x (interest and noninterest costs/ total funds raised) x (interest and noninterest cost/ 100%)

12. 100/400 x 10% / (100%-15%) + 200/400 x 11% / (100%- 5%) + 50/400 x 11% / (100% - 2 %) + 50 / 400 x 22% / 100% =12.88%