Bank Fund Management

Course Code: 6303

Chapter 4: Deposit Management

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Chapter Twelve

Managing and Pricing Deposit Services

Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-3

Key Topics

• Types of Deposit Accounts Offered

• The Changing Mix of Deposits and Deposit
Costs
• Pricing Deposit Services
• Conditional Deposit Pricing
• Rules for Deposit Insurance Coverage
• Disclosure of Deposit Terms
• Lifeline Banking

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-4

Introduction
• Deposits are a key element in defining what a banking firm
really does and what critical roles it really plays in the economy.
• Moreover, deposits provide much of the raw material for
making loans and, thus, may represent the ultimate source of
profits and growth for a depository institution.
• Two key issues every depository institution must 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 institution always has
enough deposits to support lending and other services the public
demands?
• So challenging has it become today to attract significant new
deposits that many financial firms have created a new executive
position – chief deposit officer
McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 Objectives of Bank Deposit
• Collection of bank fund
• Ensure productive investment of the scattered savings of the
clients
• Extending the scope of loan: Offer loan to depositors
• Fulfilling the excess need for money: Bank provide overdraft
facilities, which means the opportunity of withdrawing more
amounts than deposited.
• Maintaining social responsibility: payment of insurance
premium; Payment of electricity bills etc.

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
 12-6

Types of Deposits Offered by Depository

Institutions
• Transaction (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
• Nontransaction (Savings or Thrift) Deposits
▫ Longer-Term
▫ Higher Interest Rates Than Transaction Deposits
▫ Generally Less Costly to Process and Manage
McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-7

Types of Deposits Offered by Depository

Institutions (continued)
• Transaction Deposit
▫ An account used primarily to make payments for purchases of
goods and services
• Types of Transaction Deposits
▫ Noninterest-Bearing Demand Deposits
▫ Interest was prohibited by Glass-Steagall Act 1933 in US
▫ One of the most volatile and unpredictable sources of funds because they
can be withdrawn without prior notice
▫ Most deposits are held by business firms
▫ Interest-Bearing Demand Deposits
▫ Negotiable Orders of Withdrawal (NOW) are interest bearing saving
deposits that give the bank the right to insists on prior notice before the
customer withdraws funds.
▫ Money Market Deposit Account (MMDA): Interest bearing thrift
accounts whose offer rates can be adjusted frequently to reflect changing
market conditions and
▫ Super NOW: Checkable, interest bearing accounts that normally carry
higher yields than regular NOW accounts but may impose limits on
check writing.
McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-8

Types of Deposits Offered by Depository

Institutions (continued)
• Non-transaction 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: Thrifts accounts that carry relatively low
interest rates and normally can be withdrawn at any time.
▫ Statement Savings Deposit
▫ Time Deposit (CD): Thrifts accounts used primarily to encourage savings
that have a fixed maturity and carry a fixed or adjustable interest rate.
▫ Retirement Savings Deposits
▫ Individual Retirement Account (IRA) - The Economic Recovery Tax Act of 1981
▫ 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
▫ Default Option Retirement Plans – The Pension Protection Act of 2006
McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 9

Deposit Liabilities:
• Transaction Deposits: Demand Deposits; NOW
Accounts
▫ Demand Deposits, also known as checking accounts.
▫ NOW (Negotiable Order of Withdrawal) Accounts—
 pay interest; are just for individuals, governments, and nonprofits

• Savings Deposits: Savings Accounts; MMDAs

▫ Savings Accounts comprise about 15% of all deposits
▫ MMDAs (Money Market Deposit Accounts)
 comprise about 39% of all deposits; available to any
customer; interest plus limited transactional features
• Time Deposits: Certificates of Deposit; Negotiable
Certificates of Deposit
▫ Certificates of Deposit
▫ usually under $100,000; non-transferable; terms of 30 days to
5 years
▫ Negotiable (or “Jumbo”) CDs
▫ $100,000 or more; transferable or negotiable in secondary
market;
▫ terms rarely exceed 90 days

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
 Recurring Deposit Account
• While opening the account a person has to agree to deposit a
fixed amount once in a month for a certain period. The total
deposit along with the interest therein is payable on maturity.
However, the depositor can also be allowed to close the
account before its maturity and get back the money along with
the interest till that period.
• The account can be opened by a person individually, or jointly
with another, or by the guardian in the name of a minor. The
rate of interest allowed on the deposits is higher than that on a
savings bank deposit but lower than the rate allowed on a
fixed deposit for the same period.

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
 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
McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
 12-12

Interest Rates Offered on Different Types of

Deposits
• The Composition 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 deposits
▫ Core deposits: Among the most loyal and stable of a bank’s deposited
funds, normally owned by households and small businesses.
• 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 depository institutions would prefer to sell only the
cheapest deposits to the public but it is predominantly public
preference that determines which types of deposits will be created
McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-13

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
• An individual depository institution has little control over its
prices in a financial marketplace that approaches perfect
competition
▫ It is the marketplace, not the individual financial firm, that
ultimately sets prices
▫ Financial institutions, like most other businesses, are price
takers, not price makers
McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-14

Pricing Deposits at Cost Plus Profit Margin

• Bangladesh Bank limits on interest rates paid on deposits
• Establishing the rate of return or fees charged on a deposit account
based upon the cost of offering the service plus a profit margin.
• Deregulation has brought more frequent use of unbundled service
pricing as greater competition has raised the average real cost of a
deposit for deposit-service providers
• This means that deposits are usually priced separately from other
services
▫ Cost-plus pricing formula

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-15

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?

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Problem: 1
Suppose a bank has raised a total of $ 400 million, including
$100 million in checkable deposits, $200 million in time and
saving deposits, $50 million borrowed from the money market
and $50 million from its owners in the form of equity capital.
Suppose that interest and non interest costs spent to attract the
checkable deposits total 10 percent of the amount of these
deposits, while thrift deposits and money market borrowings
each cost the bank 11% of funds raised in interest and non
interest expenses. Owners’ equity is the most expensive
funding source for most banks; assume that equity capital costs
the bank an estimated 22% of any new equity raised. Suppose
reserve requirements, deposit insurance fees, and uncollected
balances (float) reduce the amount of money actually available
to the bank for investing in interest-bearing assets by 15% for
checkbook deposits, 5% for thrift deposits and 2% for
borrowings in the money market. Calculate bank’s weighted
average before-tax cost of funds.
McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
 • The bank’s weighted average before-tax
cost of funds:
[(Checkbook deposits ÷ Total funds raised) x {Interest and
noninterest fund raising costs ÷(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)}] + [(Money
market borrowing÷ Total funds raised) x {Interest and
noninterest fund raising costs ÷(100 – Percentage reserve
requirements and float)}] +[(Owners’ capital÷ Total funds
raised) x {Interest and noninterest fund raising costs ÷100]
= [(100 million ÷ 400 million) x {10 percent ÷(100 – 15
percent)}] + [(200 million÷ 400 million) x {11 percent ÷(100 – 5
percent)}] + [(50 million÷ 400 million) x {11 percent ÷(100 –
2percent)}] +[(50 million÷ 400 million) x {22percent ÷100]
= 12.88%

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
 12-18

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

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
 12-19

Using Marginal Cost to Set Interest Rates on

Deposits
• 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

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-20

TABLE 12–2 Using Marginal Cost to Choose the Interest

Rate to Offer Customers on Deposits

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-21

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.

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
 12-22

• Conditional Pricing
▫ Where a depository 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
▫ 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 over a designated period
(usually per month)
3. The maturity of the deposit in days, weeks, months, or years

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-23

EXHIBIT 12–1 Example of the Use of Conditional Deposit

Pricing by Two Banks Serving the Same Market Area

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-24

• Conditional Pricing
▫ Deposit pricing policy is sensitive to at least two factors:
1. The types of customers each depository institution plans to
serve
2. The cost that serving different types of depositors will present
to the offering institution

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-25

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.

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
 12-26

Pricing Based on the Total Customer

Relationship and Choosing a Depository
• Related to the idea of targeting the best customers for
special treatment is the notion 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

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-27

TABLE 12–3 Factors in Household and Business Customers’

Choice of a Financial Firm for Their Deposit Accounts (ranked
from most important to least important)

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-28

Basic or Lifeline Banking

Some People Feel That All Individuals

Are Entitled to a Minimum Level of
Financial Services No Matter Their
Income Level

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
 12-29

Basic (Lifeline) Banking: Key Services for

Low-Income Customers
• 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
• Among the “underbanked” are those families relying on
expensive payday loans, check cashing firms, pawnshops, and
money order services to pay their bills

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 12-30

Truth in Savings Act

• 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 Annual percentage yield (APY)

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
 Problem: Suppose that a customer holds a savings deposit in a savings bank
for a year. The balance in the account stood at $2,000 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?

• Interest Earned = 8.5

• APY = 0.82 percent,
• Where the average account balance is:
(2000 x 180 days + 100 x 185 days)/365
days
= 1036.99

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
 Factors determining the level of
deposits
Internal Factors:
• Quality of Bank personnel
• Diversified services
• Public confidence
• Interest rate
External Factors:
• State of the National Economy
• Characteristics of local economy
• Role of Government
• Relative changes in ©population
McGraw-Hill/Irwin
2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
 Bank deposit insurance scheme
in Bangladesh
• The Bank Deposit Insurance Act 2000
established the rules governing the role of
insurer, the level of coverage provided and
the laws governing the payments in event of
a bank failure. Under the law deposits of all
scheduled banks are insured up to Tk
100000 per depositor.

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
 12-34

Quick Quiz
• What are the major types of deposit plans that depository institutions
offer today?
• What are core deposits, and why are they so important today?
• How has the composition of deposits changed in recent years?
• Describe the essential differences between the following deposit pricing
methods in use today: cost-plus pricing, conditional pricing, and
relationship pricing.
• What factors do household depositors rank most highly in choosing a
financial firm for their checking account? Their savings account?
What about business firms?
• What is lifeline banking? What pressures does it impose on the
managers of banks and other financial institutions?

McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Management and Financial Services, 7/e
Copyright © 2013 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.