managing and pricing deposit services 13 july 2009

Managing and Pricing Deposit Services

13 July 2009

FINBANK SY 08-09 Term 2Ms. Kashmirr C. Ibañez

The bank’s basic problem

Where can funds be raised at the lowest possible cost

How can management ensure that the institution always has enough deposits to support the volume of loans and other investments and services the public demands?


Classification of Deposits

Direct or primary Made over the counter when the

depositor himself brings money, checks or near-cash items to the bank

Fund transfers via e-banking Derivative deposits

Created from the proceeds of loans The bank places the loan proceeds

under a current account from which the customer can draw from


Types of deposits Checking account (non-interest bearing) Savings account

Passbook ATM ATM and passbook Statement savings

Negotiable Order of Withdrawal (NOW) Time Deposits Certificates of Deposit (CDs)

Bump-up (higher interest rate if market rate rises) Step-up CDs (periodic upward adjustments in promised

interest rates) Liquid CDs – allows partial withdrawal without penalty


Philippine Landscape

Type of Account Amount (Billion PHP)

UB/KB % share of UB/KB

Demand & NOW 585.90 548.36 94%

Savings Deposits 1,416.85 1,225.01 86%

TD 775.81 565.01 73%

LTNCD 20.82 19.22 92%

Foreign Currency 807.61 764.67 95%

Type of Deposits

16%

39%22%

1%

22%

Demand & NOW Savings Deposits TD

LTNCD Foreign Currency


Ways to entice depositors

Image of financial stability Offering convenience Attractive interest rates

Motives of individuals for holding deposits•Safety•Convenience•Earnings•Accommodation


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

Factor Yield effect

Maturity Yield

Size Yield

Risk Yield


What do banks want?

More low cost and fewer high cost!- More CASA, less TD!- Less interest expense, more interest

income! More sticky deposits

CORE DEPOSITS: A stable base of funds that is not highly sensitive to

movements in market interest rates and which tend to remain with the bank.


We want it cheap!

Cheapest deposits are check accounts and interest bearing check accounts

Trade-off between operating expenses and interest expenses

Generates fee income! Bank preference:

Business accounts over individual accounts

•Check imaging•Internet banking •ATM•Check-writing

Innovations to reduce cost


The voice of the people and the power of demand

Public preference will dictate what type of deposits will be created

Individual depository institution has little control over its prices in the long run

Marketplace ultimately determines the prices

Pricing deposits


Cost Plus Profit Deposit Pricing

Deposits are usually priced separately from other services Fees for excessive withdrawals, customer

balance inquiries, bounced checks, SPO, and minimum balance charges

Unit Price Charged the

Customer for Each Service

=

Operating Expense

Per Unit of Deposit Service

+

Estimating Overhead Expense

Allocated to the Deposit

Function

+

Planned Profit from

Each Service Unit

Sold


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?


Steps in Pooled Fund Costing

Calculate the cost rate of each source of funds adjusted for reserves, insurance and float

Multiply cost rate by relative proportion of funds coming from a particular source

Sum all components to get WAC of all funds raised


Weighted Average Cost

float and RR - 100%

costs raising fundinterest -non andInterest

raised funds Total

sourceDeposit xWAC

Board Work Example: Calculate the WAC

Type of Account

Amount Raised

IC and NIC RR, Insurance, Float

CA 100 MM 10% of deposit 15%

TD 200 MM 11% of deposit 5%

Money Market borrowings

50 MM 11% of deposit 2%

Equity capital 50 MM 22% of equity


Marginal Cost Pricing the added cost (not weighted average

cost) of bringing new funds into the bank should be used to price deposits.

Two components Marginal cost of moving the deposit rate

from one level to another Marginal cost rate, the percentage of the

volume of additional funds coming into the bank


Marginal Cost Pricing

)) oldoldnewnew TFRx(IRTFRx(IRTCMC

Raised Funds Additional

Cost TotalMCR

A B C D E F G HExpected

amounts of deposits that will flow in

Average interest the bank

will pay for new funds

Total interest cost

of new funds raised

Marginal Cost of new

deposit money

Marginal Cost as a percentage of new

funds attracted (Marginal Cost

Rate)

Expected Marginal

return from investing new funds

Difference between MR and

MCR

Total profits earned after interest cost

A x B Ci - Ci-1 D/Ai-1 - Ai F - E A x (F - B)25 7.00% 1.75 1.75 7.0% 10% 3.00% 0.75050 7.50% 3.75 2 8.0% 10% 2.00% 1.25075 8.00% 6 2.25 9.0% 10% 1.00% 1.500100 8.50% 8.5 2.5 10.0% 10% 0.00% 1.500125 9.00% 11.25 2.75 11.0% 10% -1.00% 1.250

* TFR – total funds raised


Conditional Pricing

Customer pays a low fee or no fee if he deposit balance remains above some minimum level but faces a higher fee if the average balance falls below that level

Vary deposit prices based on Number of transactions passing through the

account ADB held over the period Maturity of deposit

Deposit pricing is sensitive to: Type of customer Cost of servicing different types of customers


Other pricing strategies Market penetration 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.

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.

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.

managing and pricing deposit services 13 july 2009

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