Managing and Pricing Deposit Services 13 July 2009

FINBANK SY Term 2 Ms. 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?

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez 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

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez 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

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez Philippine Landscape

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez Ways to entice depositors  Image of financial stability  Offering convenience  Attractive interest rates Motives of individuals for holding deposits Safety Convenience Earnings Accommodation

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez 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 FactorYield effect  Maturity  Yield  Size  Yield  Risk  Yield

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez 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.

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez 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

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez 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

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez 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

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez 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?

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez 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

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez Weighted Average Cost Board Work Example: Calculate the WAC Type of Account Amount Raised IC and NICRR, Insurance, Float CA100 MM10% of deposit15% TD200 MM11% of deposit5% Money Market borrowings 50 MM11% of deposit2% Equity capital50 MM22% of equity

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez 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

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez Marginal Cost Pricing * TFR – total funds raised

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez 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

FINBANK SY Term 2 Ms. Kashmirr C. Ibañez 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.