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P2.T8.20.13. Managing and Pricing Deposit Services (Rose, Chapter 12)

David Harper CFA FRM

David Harper CFA FRM
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Learning objectives: Differentiate between the various transaction and non-transaction deposit types. Compare different methods used to determine the pricing of deposits and calculate the price of a deposit account using cost-plus, marginal cost and conditional pricing formulas. Explain challenges faced by banks that offer deposit accounts, including deposit insurance, disclosures, overdraft protection and basic (lifeline) banking.


20.13.1. At commercial banks (as well as savings institutions and credit unions), deposits are the key liability. According to Rose and Hudgins, two important questions about the bank's management of deposits are: have all deposits been raised at the lowest possible cost? and, are there enough deposits to cover all loans and projects that the firm wishes to pursue? Consumers, however, can easily become confused simply because there is a dizzying array of deposit products! A high-level difference is between transaction and non-transaction deposit types. In regard to transaction versus non-transaction deposit types, which of the following statements is TRUE?

a. The least popular transaction deposit is the certificate of deposit (CD)
b. Transaction deposits are generally more profitable than non-transaction deposits
c. Core deposits exclude transaction accounts and include all non-transaction accounts that quality as Tier 1 regulatory capital
d. Compared to non-transaction deposits, transaction deposits are generally less costly to process and provide a more stable funding base

20.13.2. In pricing deposit services, financial managers are faced with an old dilemma. The institution must pay a high enough interest to keep customers happy and to attract new customers, while at the same time not paying too high an interest rate that it erodes the firm’s expected profit margin. Rose and Hudgins review four different methods a bank can use to determine the pricing of deposits: cost-plus, marginal cost, conditional pricing, and relationship pricing. In regard to these approaches, each of the following summaries is accurate (TRUE) EXCEPT which statement is inaccurate (FALSE)?

a. The cost-plus approach requires the careful allocation of operating, overhead and other fixed costs
b. The marginal cost approach in theory should maximize the amount of deposits attracted and therefore generate the highest revenue and interest income
c. The conditional pricing approach varies deposit prices (ie, offered interest rate) based on number of transactions, average balance, and/or maturity of deposits
d. The relationship pricing approach offers lower fees and/or higher interest rates to customers who use a greater number of bank services

20.13.3. Banks that offer deposit accounts face several challenges on several fronts, including those related to deposit insurance, disclosures, overdraft protection and basic (lifeline) banking. In this regard, which of the following statements is TRUE?

a. Interest rates are the most important factor that customers consider when choosing an institution to hold their deposit accounts
b. Deposit insurance compensates the bank for a sudden, unexpected withdrawal by the customer but requires the bank to pay higher interest rates
c. The Truth in Savings Act applies only after an account has been opened and does not apply to transaction deposit accounts (ie., only to non-transaction accounts)
d. Lifeline banking is a controversial social issue that asks whether banks should be obligated to offer certain basic banking services to the unbanked and underbanked

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