1. Bank Management & Financial Services BF465
UNILUS
2015

2. Managing & Pricing Deposits
01/10/2017
Managing & Pricing Deposits

3. Sources of bank funds Non Deposit sources of Funds
01/10/2017
Sources of bank funds
Non Deposit sources of Funds
Sources other than bank depositors (Financial instruments, Interbank borrowings, etc)
Generally more expensive sources
Deposit sources
Mostly from bank customers depositing or opening accounts with the bank
Cheaper sources in comparison to other sources of funds

4. Sources of bank funds
01/10/2017
Deposits are a key element in defining what a banking firm really does in an economy.
The ability to attract depositors (business & consumer) is very important measure of the bank’s acceptance by the public
Deposits provide the raw material for making loans
An important measure of management’s effectiveness is the ability to mobilize cheaper deposits
Deposit pools should be sufficient enough to meet the loan demand

5. Sources of bank funds Types of deposits Current account deposits
01/10/2017
Sources of bank funds
Types of deposits
Current account deposits
Saving account deposits
Demand Deposit accounts (Call accounts)
Retirement pension funds

6. 01/10/2017
Interest rate factors
Each deposit category carries a different rate of interest
Generally, the longer the maturity the higher the interest yield
The size of the depository institution and perceived risk exposure is another factor. The bigger the depository firm the lower will be the rates of interest
The market philosophy of the bank or financial services industry is another factor influencing interest rates being offered on the deposits. The more competitive the market place is the higher the interest rates will be offered by banks

7. 01/10/2017
Interest rate factors
Changing customer preferences also determine the rates of interest being offered. Deposit rates should be high enough to attract depositors at the same time should not be too high to erode profits
Conditional pricing – banks varying pricing based on customers meeting the various conditions. eg minimum number of transactions, average balances held, time to maturity, etc. Depositors qualify for higher rates only upon meeting the set conditions
Total relationship based pricing

8. Costing of deposit accounts
01/10/2017
Costing of deposit accounts
Holding everything constant, Managers of deposit institutions prefer to raise funds by selling cheaper deposits or those generation higher net revenues
The cheaper deposits are then invested in high yielding assets thereby maximizing the spread

9. Sources of cheaper deposits
01/10/2017
Sources of cheaper deposits
Current accounts (interest earning or non interest earning). Key factor to look out for is the management and handling cost of current accounts products eg cheque processing, etc
Savings accounts
Bill Payment solutions
Cash management solutions

10. Pricing of Deposits
01/10/2017
In a perfect market place banks have little control over price of deposits.
The following are the common pricing models ;
Below cost pricing model (Mostly relationship based or competition pushed)
Capped interest model (Mostly regulatory)
Cost plus margin model (Most common)

11. Pricing of Deposits
01/10/2017
Marginal costing model is the most common practice in Zambia. Marginal costing takes into account the additional cost of bringing in new funds
Marginal cost (The added cost of bringing in new funds) should be used to help price funds sources instead of using the historical average costing method.
Frequent changes in interest rates will make the historical average costs an ineffective standard of pricing. For example if interest rates are declining or going up, there could be distortions in the profitability of existing deposit portfolios in comparison to the marginal cost of new funds

12. Pricing of Deposits Marginal cost = Change in Total Cost
01/10/2017
Marginal cost = Change in Total Cost
MC = (New interest rate X total funds raised at new rate) – (Old interest rate X total funds raised at old rate)
Therefore ;
Marginal Cost Rate = Change in Total Cost/Additional funds raised

13. Pricing of Deposits
01/10/2017
Suppose a bank wants to raise K25 million worth of new deposits at 7%.
If management offers 7.5% the bank will raise K50 million.
If it offers 8% it will raise K75 million, at 8.5% it would raise K100 million and at 9% the bank believes it can raise K125 million.
The bank wishes to invest the new deposits in securities yielding 10% (marginal revenue)

14. Pricing of Deposits Marginal cost = Change in Total Cost
01/10/2017
Marginal cost = Change in Total Cost
MC = (New interest rate X total funds raised at new rate) – (Old interest rate X total funds raised at old rate)
Therefore ;
Marginal Cost Rate = Change in Total Cost/Additional funds raised
If the bank raises its offer rate on new deposits from 7% to 7.5%, what will be the Change in total cost of this change?

15. Pricing of Deposits
01/10/2017
Change in total cost = (K50,000,000 X 7.5%) – (K25,000,000 X 7%) = K2,000,000
What is the Marginal Cost Rate?
Change in Total Cost/Additional funds raised = 2,000,000/K25,000,000 = 8%
Note that the marginal cost rate of 8% is higher than the 7.5% average deposit cost!
Why??

16. Pricing of Deposits
01/10/2017
Since the bank expect to earn 10% on the new funds, marginal revenue exceeds marginal cost by 2% at a deposit interest rate of 8%.
The new deposits will add more to revenue than to cost
Calculate the total profit arising from injecting in additional funds
Total Revenue – Total Cost
(K50,000,000 X 10%) – (K50,000,000 X 7.5%) = K 1,250,000

17. New Deposits
K’000,000
Average interest of new funds
Total interest cost of new funds
Marginal cost of new funds
Marginal cost rate
Expected marginal revenue
Marginal revenue – marginal cost rate
Total profit earned 25
7.0%
1.75
10.0%
+3%
0.75 50
7.5%
3.75
2.00
8.0%
+2%
1.25 75
6.00
2.25
9.0%
+1%
1.50
100
8.5%
8.50
2.50 +0
125
11.25
2.75
11.0%
-1%