Chapter Twelve

Managing and Pricing Deposit Services

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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
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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 publics deposits

Where can funds be raised at lowest possible cost?

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
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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
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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
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 due to
Garn-St Germain Depository Institution Act of 1982
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Types of Deposits Offered by Depository

Institutions (continued)
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
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

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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 lowyielding 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 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

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TABLE 121 The Changing Composition of Deposits in the

United States

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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

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
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Pricing Deposits at Cost Plus Profit Margin

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 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

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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

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TABLE 122 Using Marginal Cost to Choose the Interest

Rate to Offer Customers on Deposits

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Using Marginal Cost to Set Interest Rates on

Deposits
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.

2.
3.

The number of transactions passing through the account (e.g.,

number of checks written, deposits made, wire transfers, stoppayment 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

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EXHIBIT 121 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 on

Deposits
Conditional Pricing
Deposit pricing policy is sensitive to at least two factors:
1.
2.

The types of customers each depository institution plans to

serve
The cost that serving different types of depositors will present
to the offering institution

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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

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TABLE 123 Factors in Household and Business Customers

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

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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
Racial and ethnic minorities are substantially more likely than
the general population to be underbanked
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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 APY

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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 does the 1991 Truth in Savings Act require financial firms
selling deposits inside the United States to tell their customers?
What is lifeline banking? What pressures does it impose on the
managers of banks and other financial institutions?
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