Banking Management

Unit-6

Pricing Deposit Products and Services

By
Arpan Paudel 1
The purpose of this chapter is to explore how a bank’s cost of funding can
be determined and examine the different methods open to banks to price
the deposits and deposit-related services they sell to the public.

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Areas of Frequent Dilemmas.

1. Where can funds be raised at lowest possible cost?

2. How can management ensure that there are enough
deposits to support lending and other services the public
demands?
• Deposits: foundation upon which banks thrive and grow
• Important measure of the bank’s acceptance by the public

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 What may be the
Interest Rate Movement of Nepali Commercial Banks reason?
A.Interbank Rate (Commercial Banks) B. Weighted Average Deposit Rate (Commercial Banks) C. Weighted Average Lending Rate (Commercial Banks) D.Base Rate (Commercial Banks)$

14,00

12,00

10,00

8,00

6,00

4,00

2,00

0,00 4
2019 2019 2019 2019 2019 2019 2019 2019 2019 2019 2019 2019 2020 2020 2020 2020 2020 2020 2020 2020 2020 2020 2020 2020 2021 2021 2021
JAN FEB M AR APRIL M AY JU NE JU LY AU G S E P OCT NOV DEC JAN FEB M AR APRIL M AY JU NE JU LY AU G S E P OCT NOV DEC JAN FEB M AR

Source: NRB
FD Interest Rate Movement of Nepali Commercial Banks What may be the
reason?

Source: NRB
Saving Deposit Interest Rate Movement of Nepali Commercial Banks
What may be the
reason?

6 Source: NRB
Historical Review

• The Glass-Steagall Act of 1933 – Federal Limits

on Interest Rates Paid on Deposits – why?
• Non price Competition: gifts, privileged
banking,..
• The Depository Institutions Deregulation Act of
1980 – pricing strategy shifted from public
regulator to private decision makers.
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Recent Trends

 Both the cost and amount of deposits banks can sell to the
public are heavily influenced by:
 Pricing Schedules and Competitive Maneuverings of Other
Financial Institutions
 Competitors: Mutual Funds, Credit Unions, Cash Management
Accounts at Brokerage Firms and Insurance Companies, and
Interest-Bearing Investment Accounts Offered by Securities
Firms
 Innovation: new deposit plans, service delivery methods
 An Important Executive Position of the Chief Deposit Officer
Deposit Pricing Depend On:

 The Maturity of the Deposit

 The Size of the Offering Bank
 The Risk of the Offering Bank
 Marketing Philosophy and Goals of the
Offering Bank

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Truth in Savings Act

 Consumers Must be Informed of the Deposit Terms Before

They Have a New Account
 -Depository Institutions Must Disclose:
 Minimum Balance to Open
 Minimum to Avoid Fees
 How the Balance is Figured
 When Interest Begins to Accrue
 Penalties for Early Withdrawal
 Options at Maturity
 And the Annual Percentage Yield (APY)

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Types of Deposit Pricing

 Cost-Plus Profit Margin

 Marginal Cost of Deposits
 Market Penetration Deposit Pricing
 Conditional Pricing
 Upscale Target Pricing
 Relationship Pricing 11
1. Cost Plus Profit Margin

• Numerous deposit products with low-balance and high-activity

have ballooned the operating costs of banks.
▫ Below-cost pricing: gives implicit interest rate to depositors
▫ Non price competition: gifts, convenient banking (privileged)
• Each deposit service is priced high enough to recover all or most
of the cost of providing that service. Eg. charging for balance
inquiry, excessive withdrawal, ATM, monthly/annual maintenance
fees, raising required minimum deposit balances.

Estimating
Unit Price Operating Planned
Overhead
Charged the Expense Profit from
Expense
Customer = Per Unit of + + Each
Allocated to
for Each Deposit Service Unit
the Deposit
Service Service Sold
Function
 Historical Average Cost Approach

Determines the Bank’s Cost of Funds by Looking at

the Past. It Looks at What Funds The Bank Has
Raised to Date and What Those Funds Have Cost

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 Estimating Average Deposit Service Cost:

 Cost-plus pricing demands an accurate calculation of the

cost of each deposit service. How can this be done?
 Simon & Marks (1980): is to base deposit prices on the
bank’s estimated cost of funds
1. Calculate the cost rate of each source of the bank funds
(adjusted for reserves required, deposit insurance fee)
2. Multiply each cost rate by the relative proportion of bank
funds coming from that particular source
3. Sum all resulting products to deliver the weighted average
cost of bank funds
--- called Pooled-funds-approach
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 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?

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 2. Marginal Cost of Deposit

 Many Financial Analysts Would Argue That the Added

Cost (Not Weighted Average Cost) of Bringing New
Funds into the Bank Should Be Used to Price
Deposits.
 Because frequent changes in interest rates will make
average cost a treacherous and unrealistic standard
for pricing
 If Int. rate declining– mkt. do have lower rate than
average and vice versa. 16
 Using Marginal Cost to Set Interest Rates on Deposits…

Q. Suppose a bank expects to raise $ 25 million in new deposits by offering int. rate
of 7% . Management estimates that if the bank offers a 7.5% raises $50 million,
8% raises $75 million, 8.5% raises $100 million and 9% will raise $125 million in
the form of both new deposits and existing deposits . It is assumed that the bank
can invest the deposit money at a yield of 10%. What deposit interest rate
should the bank offer its customers?
Soln:

 The 8.5% deposit rate is the best choice

17 for the bank.
3. Market Penetration Deposit 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.

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4. Conditional Pricing

 A Conditional Method of Pricing Deposit Services in

Which the Fees Paid by the Customer Depend Mainly
Upon the Account Balance and the Volume of
Account Activity

 Schedule of Fees were Low If Customer Stayed

Above Some Minimum Balance - Fees Conditional On
How the Account Was Used

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Deposit Fee Schedules
 Conditional Pricing Based On One or More Of the
Following Factors:

1. The Number of Transactions Passing Through the Account

2. The Average Balance Held Over Some Designated Period
3. The Maturity of the Deposit in Days, Weeks or Months

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5. 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.

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6. 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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Unit Assignment-6
Quiz
(Multiple Choice Questions)

10 Objective Questions will be updated in VC with 10 minute duration and single attempt retraction
(examination day will be as decided in class).

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