Chapter Twelve Managing and Pricing Deposit Services Mc

Chapter Twelve Managing and Pricing Deposit Services Mc. Graw-Hill/Irwin Copyright © 2010 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

12 -2 Key Topics • Types of Deposit Accounts Offered • The Changing Mix of Deposits and Deposit Costs • Pricing Deposit Services and Deposit Interest Rates • Conditional Deposit Pricing • Rules for Deposit Insurance Coverage • Disclosure of Deposit Terms • Lifeline Banking Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -3 Key Issues Depository Institutions Are Faced With: 1. Where can funds be raised at lowest possible cost? 2. How can management ensure that there are enough deposits to support lending and other services the public demands? Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -4 Recent Trends • Pricing Schedules and Competitive Maneuverings of Other Financial Institutions • Competitors: Mutual Funds, Credit Unions, Cash Management Accounts at Brokerage Firms and Insurance Companies, and Interest-Bearing Investment Accounts Offered by Securities Firms • An Important Executive Position of the Chief Deposit Officer Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -5 Types of Deposit Accounts • Transaction (Payment or Demand) Deposits ▫ Making Payment on Behalf of Customers ▫ One of The Oldest Services ▫ Provider is Required to Honor Any Withdrawals Immediately • Nontransaction (Savings or Thrift) Deposits ▫ Longer-Term ▫ Higher Interest Rates Than Transaction Deposits ▫ Generally Less Costly to Process and Manage Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -6 Transaction Deposit An Account Used Primarily to Make Payments for Purchases of Goods and Services Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -7 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)hybrid savings instrument ▫ Money Market Deposit Account (MMDA) and Super NOW due to Garn-St Germain Depository Institution Act of 1982 Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -8 Nontransaction (Savings or Thrift) Deposit An Account Whose Primary Purpose is to Encourage the Bank Customer to Save Rather than Make Payments Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -9 Types of Savings or Thrift Deposits • Passbook Savings Account • Statement Savings Deposit • Time Deposit (CD) • Individual Retirement Account (IRA) - The Economic Recovery Tax Act of 1981 • Keogh Deposit – have tax benefits • Roth IRA – The Tax Relief Act of 1997 Allows Non-Tax-Deductible Contributions • Default Option Retirement Plans – The Pension Protection Act of 2006 Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -10 Popular Types of CDs • Bump-Up CD – Allows a Depositor to Switch to a Higher Interest Rate if Market Rates Rise • Step-Up CD – Permits Periodic Upward Adjustments in the Promised Interest Rate • Liquid CD – Permits the Depositor to Withdraw Some or All of Their Funds Without a Withdrawal Penalty Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -11 Interest Rates on Deposits Depend On: • The Maturity of the Deposit • The Size of the Offering Institution • The Risk of the Offering Institution • Marketing Philosophy and Goals of the Offering Institution Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -12 The Changing Composition of Deposits in the US Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -13 Core Deposits A Stable Base of Funds that is Not Highly Sensitive to Movements in Market Interest Rates (Low Interest. Rate Elasticity) and Which Tend to Remain with the Bank Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -14 Check 21 and Substitute Checks • Effective October 28, 2004 – Permits Depository Institutions to Electronically Transfer Check Images • The Images are Called Substitute Checks and is a Legal Copy of the Check • Protects Depositors Against Loss • Benefits Institutions by Reducing the Cost of Check Clearing • Substitute Checks Can Be Sent Electronically Instead of Sending Bundles of Checks • More Information: http: //www. federalreserve. gov/ Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -15 FDIC Insurance Coverage • Banks Insured Through Bank Insurance Fund (BIF) • Savings and Loans Insured Through Savings Association Insurance Fund (SAIF) • Covers Only Those Deposits Payable in the U. S. • Many Types of Accounts are Covered Up To $100, 000 (increased to $250, 000 until yearend 2009 by the Emergency Economic Stabilization Act of 2008) for Each Account Holder within the Same Bank (Even if Different Branches) • Deposits Placed in Separate Institutions are Mc. Graw-Hill/Irwin © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved. Bank Management and Financial Services, 7/e Insured Separately

12 -16 Truth in Savings Act • Consumers Must be Informed of the Deposit Terms Before They 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 And the APY Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -17 Pricing Deposit-Related Services • The Glass-Steagall Act of 1933 – Federal Limits on Interest Rates Paid on Deposits – why? • Nonprice Competition • The Depository Institutions Deregulation Act of 1980 ▫ ▫ Cost-Plus Pricing Marginal Cost of Deposits Conditional Pricing Relationship Pricing Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -18 Cost Plus Profit Deposit Pricing Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -19 The Marginal Cost Approach: Historical Average Cost Approach Determines the Bank’s Const of Funds by Looking at the Past. It Looks at What Funds the Bank Has Raised to Date and What those Funds Have Cost Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -20 Pooled Funds Approach Determine the Bank’s Cost of Funds by Looking at the Future. What minimum Rate of Return is the Bank Going to Have to Earn on Any Future Loans and Securities to Cover the Cost of all New Funds Raised? Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -21 Using Marginal Cost to Set Interest Rates on Deposits Many Financial Analysts Would Argue That the Added Cost (Not Weighted Average Cost) of Bringing New Funds into the Bank Should Be Used to Price Deposits. Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -22 Market Penetration Deposit Pricing The Method of Selling Deposits That Usually Sets Low Prices and Fees Initially to Encourage Customers to Open an Account and Then Raises Prices and Fees Later On. Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -23 Conditional Pricing • Schedule of Fees were Low If Customer Stayed Above Some Minimum Balance Fees Conditional On How the Account Was Used • Conditional Pricing Based On One or More Of the Following Factors ▫ The Number of Transactions Passing Through the Account ▫ The Average Balance Held in the Account During the Period ▫ The Maturity of the Deposit Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -24 Upscale Target Pricing Bank Aggressively Goes After High. Balance, Low-Activity Accounts. Bank Uses Carefully Designed Advertising to Target Established Business Owners and Managers and Other High Income Households. Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -25 Relationship Pricing The Bank Prices Deposits According to the Number of Services Purchased or Used. The Customer May Be Granted Lower Fees or Have Some Fees Waived If Two or More Services are Used. Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -26 Basic or Lifeline Banking Some People Feel That All Individuals Are Entitled to a Minimum Level of Financial Services No Matter Their Income Level Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -27 Quick Quiz • What are the major types of deposit plans offered today? • What are core deposits, and why are they so important? • How has the composition of deposits changed in recent years? • A bank determines from an analysis of its costaccounting figures that for each $500 minimumbalance checking account it sells, account processing and other operating costs will average $4. 87 per month and overhead expenses will urn an average of $1. 21 per month. The bank hopes to achieve a profit margin over these particular costs of 10 percent of total monthly costs. What monthly fee should it charge a customer who opens one of these checking accounts? Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 -28 Quick Quiz (cont. ) • Suppose that a customer holds a savings deposit in a savings bank for a year. The balance in the account stood at $2000 for 180 days and $100 for the remaining days in the year. If the savings bank paid this depositor $8. 50 in interest earnings for the year, what APY did this customer receive? (Use the formula required by the Truth in Savings Act) Mc. Graw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.