Deposit Pricing – Is Your Bank Prepared For This Coming Change?

Bank Deposits

As of December 2014, there were 6,518 FDIC insured financial institutions.  Of the total number of insured financial institutions, 1,872 were less than $100mm in total assets while 3,477 were less than $200mm in total assets.  At the top of the asset range, there were only 36 institutions with assets greater than $50B, and those 36 institutions account for 71% of all assets ($11.06B), 63% of all loans ($5.23B), and 69% of all deposits ($8.2B).  The above data speaks to the concentration in the banking industry with all of its attendant problems for consumers, regulators and competitors. 


Community banks do not need to emulate the national banks, as our community bank business model is very different.  However, it helps our competitive position to understand the trends and forces at work for the 36 largest banks because they control such a large percentage of the loan and deposit market. 


The larger banks have historically made substantial use of the commercial paper market to fund their operations.  In fact, for the larger banks, commercial paper historically comprised 14% of all interest rate liabilities.  Institutional prime money funds are the largest buyers of banks’ commercial paper.  New regulation, passed as the result of the financial crises, mandates that institutional prime money funds will have to report daily prices, which may fluctuate based on their underlying holdings. These rules are intended to safeguard money funds.  Government-only funds, which invest in securities such as Treasury bills, will have fewer restrictions. 


The result is that money funds will be buying less financial commercial paper which also means that most all large banks will cut their reliance on commercial paper. This will bring the large bank back into the deposit market to raise a substantial amount of funds thereby driving up the cost. In the past six months, one-month commercial paper rates for banks have increased 0.03% to 0.16% while yields for similar-maturity Treasury bills have decreased 5 bps to zero.  The same phenomenon has occurred with LIBOR, where rates have climbed by 4 bps to 0.2775% in the last six months.  While these increases are small in absolute terms, they are large given the proportion of the rate movement, especially when general market interest rates have not moved higher.


Before community banks start celebrating that national banks’ cost of funding is rising, and will rise even more rapidly as interest rates rise, keep in mind that this group of banks controls 69% of all deposits and 74.4% of all DDAs.  That means that deposits and specifically DDAs will be a larger source of funding for larger banks.  The alternative, commercial paper, will be more expensive.  This will have two important results - higher rates on all deposits when rates rise and much higher betas (sensitivity) on deposits.  If almost three-quarters of national deposits are more rate sensitive and higher in rate (in relation to fed funds), the competition will be forced to match.


The above partially explains why the national banks model their DDA with betas equal to 1.0. This is surprising, but true.  One way that community banks can defend the value of their retail deposit base is to build out treasury management services to capture larger and higher quality DDA.  Having a robust cash management offering should be a strategic imperative at every bank and will help banks increase customer retention and lifetime value, build C&I loans, and generate much needed fees.