1. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-1 Deposit and Liability Management Chapter 15

2. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-2 Challenges Faced by Depository Institutions Lower percentage of assets financed by core deposits Higher technology costs for deposit operations Changes in the payments system

3. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-3 How They Have Responded Greater reliance on noncore sources of funding Securitization as a source of liquidity Rapid growth in total deposits Expansion in number of bank branches Creation of virtual banks New Market Innovations and Service Attractiveness Increase in services offered Improved customer service

4. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-4 Typical New Services Check-clearing services for other banks Lockboxes, working capital management services Controlled disbursement accounts Account reconciliation Sweep accounts Payroll services Mini-branches in supermarkets, other stores

5. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-5 Responses (continued) Significant use of technology Check imaging systems Greater use of ◦ ATMs ◦ Debit cards ◦ Online banking Cyberbanks or “virtual” banks Electronic funds transfers Innovative deposit products Increased use of deposit service charges Lifeline banking

6. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-6 Bank Operations & Technology Operations Check clearing, debiting and crediting accounts Producing and mailing customer account statements All electronic transactions Difficulties Avoid mistakes and errors in coding, transfers Prevent fraud, “hacking,” identity theft Monitor and report suspicious activity under the Bank Secrecy Act and the USA Patriot Act

7. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-7 Factors Affecting the Financing of the Institution Assets are funded by deposits, liabilities, and equity Factors affecting choice of financing Type of lending and loan rates Sophistication of depositors Branching system Services and convenience offered, fees charged Advertising Reputation Activity of competitors

8. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-8 Average Liability Mix As a percent of total assets as of 12/31/2003 FDIC-insured banks and savings institutions Total liabilities90.85% Total deposits65.60 Total non-deposit liabilities25.25 Equity capital 9.15 Total liabilities and equity 100.00% Source: Summary of table on page 551.

9. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-9 Considerations in the Pricing of Deposits The Marginal Cost of Funds Setting Explicit Interest Rates Costs Incurred for Specific Account-Related Services Different Pricing Strategies Estimating the Marginal Cost of a Deposit Account

10. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-10 Estimating the Marginal Cost of a Deposit Account where I = current market interest rate on type of deposit S = servicing costs of deposits (expressed as percentage of each dollar acquired) DI = deposit insurance premium (expressed as percentage of each insured dollar) RR = Fed reserve requirement of type of deposit

11. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-11 Example Current market rate on NOW account is 6.5% Cost of servicing the NOW account is 3.4$ Deposit insurance premium is 0.254% Fed reserve requirement is 10.0% The marginal cost of a NOW account deposit is

12. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-12 Retail Deposit Accounts Demand deposits NOW accounts SuperNOW accounts Money market deposit accounts Passbook savings Nonnegotiable certificates of deposits Individual retirement accounts Jumbo negotiable CDs

13. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-13 Other Sources of Financing Fed Funds Purchased Eurodollar Deposits Repurchase Agreements Mortgage-Backed Bonds Deposit Notes and Bank Notes Bank Notes

14. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-14 Secondary Sources of Capital Funding sources Subordinated debt Preferred stock Trust preferred stock

15. Copyright © 2004 by Thomson Southwestern All rights reserved. 15-15 Deposit Insurance Premiums Risk-based and dependent on How well bank is capitalized Regulator’s assessment of risk Current assessment rate schedule (BIF & SAIF) Capital GroupABC Well0 bp3 bp17 bp Adequate3 bp10 bp24 bp Under10 bp24 bp27 bp Supervisory Subgroup