managing and pricing deposit services 13 july 2009
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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?
FINBANK SY 08-09 Term 2Ms. 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 08-09 Term 2Ms. 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 08-09 Term 2Ms. Kashmirr C. Ibañez
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
FINBANK SY 08-09 Term 2Ms. 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 08-09 Term 2Ms. 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
Factor Yield effect
Maturity Yield
Size Yield
Risk Yield
FINBANK SY 08-09 Term 2Ms. 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 08-09 Term 2Ms. 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 08-09 Term 2Ms. 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 08-09 Term 2Ms. 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
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
FINBANK SY 08-09 Term 2Ms. 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 08-09 Term 2Ms. 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 08-09 Term 2Ms. Kashmirr C. Ibañez
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
FINBANK SY 08-09 Term 2Ms. 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 08-09 Term 2Ms. Kashmirr C. Ibañez
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
FINBANK SY 08-09 Term 2Ms. 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 08-09 Term 2Ms. 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.
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