Are we paying too much for deposits?

January 8, 2007  A quarterly survey released last week by Citigroup Inc. noted that while a few banks have followed the Fed's lead and trimmed rates, most have been offering deposit promotions that are well above the federal-funds target rate of 4.25%.

Why are banks still scrambling for deposits?  Because loan demand remains strong.  Banks fund loans with deposits, typically a less costly source of funds than borrowing.

Banks are already earning less on loans, contributing to a narrowing in net interest margin, a key measure of profitability. Net interest margins reflect earnings made on the difference between rates paid to depositors and rates charged to borrowers.

The industry average for net interest margin for the third-quarter 2007 stood at 3.78%, according to SNL Financial, a Charlottesville, VA, research firm. The margin now stands at the lowest level since 1991.  In early 2006, the industry average was 4%.

In a report issued Monday, Bank of America Corp. estimates that the industry will likely see fourth-quarter net interest margins drop by 0.05 to 0.15 percentage point.

The squeeze on the margin may be felt the most in small banks, which may derive a substantial amount of their profits from interest income, which can account for up to 80% of total profits.

Marketers need to contribute to bottom-line income by focusing on increasing share of customer wallet.  Free checking, without excellent cross-selling capabilities, should be de-emphasized.  With pressure to increase net interest margins, rates will be less effective as a means to attract new business.  Convincing checking customers to accept monthly fee-based accounts will remain a key challenge.

Posted by Mark Rodrigues at 1/9/2008 3:33 PM
Categories: Deposits, Checking Accounts, Management
 

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