Reverse Elasticity Drives up Deposit Balances

Dan Geller
August 31, 2010

Who ever heard of a deposit market where banks can lower their rates below their market average and yet still see their balances go up? And yet that is exactly what we are seeing right now.

It's called “rate minimization,” where banks literally push their rates to the floor to continue raising funds rather than trying to match the top payers, as would be the case under “rate optimization.” And it's all being enabled by an extremely unusual phenomenon known as “reverse elasticity of demand.”

The favorable implication for bank pricing managers is that they can (for now) lower their cost of funds without jeopardizing liquidity levels. The unpleasant implication for consumers is that returns on their certificates of deposit (CDs) and money market funds will continue to drift lower.

Abnormal Dynamics

Traditionally, deposit pricing followed the economic model of price elasticity of demand, which states that when interest rates fall, balances drop as well – and vice versa. The opposite of elasticity is inelasticity, when balances do not fluctuate when interest rates go down. Clearly, deposit-pricing behavior is not homogenous and regional or product variations may exist. Yet some of the new dynamics between interest rates and deposit balances can only be described as “abnormal” and trending toward inelasticity.

For example, a recent analysis by Market Rates Insight (MRI) found that balances of transaction accounts rose by $281 billion despite a decline of 1.19% in the interest rates paid on transaction accounts. Similarly, another analysis shows that overall deposit balances in institutions insured by the Federal Deposit Insurance Corporation have risen continuously despite a steady decline in deposit rates since the fourth quarter of 2006.

Two major factors and one indicator collectively contribute to the reverse elasticity condition in the deposit market. The first factor is the state of mind of the consumer. With U.S. consumer sentiment at an 11-month low because of near record high unemployment, a soft housing market and disappointing growth in the economy overall, people are opting to keep their money as liquid as possible – i.e., in checking and savings accounts that they can tap immediately. Thus, a lower interest rate on transaction accounts does not deter consumers from adding balances to these accounts, which explains why balances are growing despite declining rates.

The second factor is the lack of substitution. The volatile stock market makes mutual funds unpredictable. Having been stung badly in 2008-2009, the individual investor (unlike the institutional investor) flocks to the safety and security of insured deposits – undeterred by the low interest rates.

The main indicator that contributes to the new environment in deposits is the decline in the bottom rates of deposits – rates that are used for balance maintenance and automatic rollovers. For example, the latest analysis from MRI shows that between July 2009 and July 2010, the average of the lowest rates offered on CDs dropped from an annual percentage yield (APY) of 0.47% to 0.26% – a decline of 21 basis points. The deepest decline in the lowest rates occurred with 30-month CDs, which fell from 0.75% to 0.15% during the period – a drop of 60 basis points. Clearly, institutions that have lowered their bottom rates accordingly are benefiting from a lower cost of funds without any major shift in balances.

As a result of this new dynamic between interest rates and balances, institutions are starting to shift their pricing approach from rate optimization to rate minimization. Under rate optimization, which follows the traditional elasticity model of demand, the practice is to measure the impact of rate fluctuation on balances, accounting for the highest competitive rates as intervening variables. Conversely, in the model of reverse elasticity, the intervening variables are the lowest rates offered by the competitive set rather than the highest. The reason for the shift, from the highest to the lowest, is our statistical finding that when the independent variables (rates) go down, the dependent variable (balances) go up.

For this reason, institutions are starting to practice rate minimization in cases where the reduction in rates shows no adverse impact on balances, or even an increase in balances. Deposit-pricing managers can easily identify opportunities for rate minimization by analyzing reports showing the lowest APY for each product and by using the lowest rates as the intervening variable in their pricing models. Such rate minimization makes good business sense because it lowers an institution's cost of funds without jeopardizing its liquidity levels.

Dan Geller is executive vice president for Market Rates Insight, where he oversees research and analytical services. He can be reached at dan.geller@marketratesinsight.com. Reprinted with permission from BAI's online publication Banking Strategies at http://www.bai.org/bankingstrategies.

Remote Deposit Capture is Focus of New Tech Council White Paper

CUNA Councils
August 24, 2010

Remote Deposit Capture (RDC) promises to extend greater convenience to members while at the same time potentially reducing operational costs and investment in building infrastructure, according to a new white paper from the CUNA Technology Council.

RDC is when a member or business account holder utilizes an optical scanning device, such as a home-office scanner or mobile cell phone camera, to capture (scan) images of checks for deposit, upload them to a computer on site, and through a software application, edit and send the front and back images securely over the Internet to the credit union for processing and deposit.

As noted in “Remote Deposit Capture: Thinking Out of the Branch To Better Serve Members,” RDC is a valuable tool for credit unions that have:

• members who reside some distance away from a branch
• members who frequently travel or are stationed in other countries
• members whose college-age children are in a location without a branch
• members who wish or need to make deposits during non-business hours

RDC may also prove useful to credit unions that have a small number of branches in comparison to a large field of membership, as is the case with some select employee group (SEG)-based credit unions.

The new white paper covers key points related to RDC and RDC application development, including:

• the business rationale for offering Remote Deposit Capture
• eligibility criteria and deposit limits
• hardware and software considerations, including functionality and platform expansion
• image correction concerns
• vendor partnership
• fraud detection and risk management controls, including duplicate detection
• the importance of member education and trained back-up support

In addition, four credit unions are profiled through in-depth case studies, providing the reader with an understanding of how remote deposit capture functions as well as its primary challenges and advantages.

CUNA Council members are entitled to complimentary copies of these and more than 200 white papers; non-members may purchase the white papers for a price of $50 per copy.

The paper is available online in the white paper section of each council site – select the “Tech” tab.

Member Spotlight: Michael Daugherty

CUNA Councils
August 23, 2010

Michael Daugherty is president of the $13-million Community Plus Federal Credit Union in Rantoul, Illinois. His background includes lending, sales, accounting, and management. He has been a CPA since 1994.

Biggest challenge

Returning to profitability after a branch expansion. It was part of our business plan to run a deficit for several years, but the recession and the corporate credit union crisis has added to the challenge.

Best advice

If you run a good operation, you can stand up for yourself proudly.

Greatest benefit of Council membership

Sharing of information, especially in the list serve.

Best part of my job

I am constantly doing something different.

Hardest part of my job

Dealing with regulatory changes.

Success story

After years of trying to compete with auto dealers' captive financing we began paying incentives for them to send us business. It isn't indirect lending, but in some ways it is better.

Biggest misconception about my job

That I am a banker.

Hobbies and interests

I like to work around the house and garden and attend my children's athletic events. I am interested in science, technology, and aviation.

Recent book

A collection of articles on the air war in the Pacific during World War II. It was published in the 1960s and contains many first-hand accounts.

Life goal not yet accomplished

Visit Australia.

Something that always makes me laugh

Irony.

Favorite quote

“Faith makes all things possible—not easy.”

Musical preferences

Whatever it is, it was most likely first played 30 years ago.

If I could spend a day with anyone it would be . . .

George Will. I may not agree with his political philosophy, but I admire his intellect and his writing. And he knows baseball like no one else outside of the game!

How I would explain the credit union difference to a prospective new member

I would provide examples. Like the man yesterday whose son died unexpectedly. The man had recently made a $5,000 prepayment on his car, but needed the money back. We took care of him, and at the end he thanked us and said only his credit union would have done this for him.

Effective Strategies for Credit Card Pricing is Subject of Latest OpSS Council White Paper

CUNA Councils
August 19, 2010

Credit unions have a real opportunity to gain credit card market share from banks today, according to a new white paper by the CUNA Operations, Sales & Service (OpSS) Council. Even before the Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD Act) took effect, big banks were drawing consumers' ire, between the bailouts, their reactions to the economy's effects on their credit card programs and their preparations for the new regulatory environment.

The new paper, “Credit Card Pricing: Effective Strategies for a Post-CARD Act Market,” notes that with a well-designed, competitive value proposition—including pricing strategies that make their cards attractive without posing excessive risk—and a comprehensive marketing/communications plan that trumpets the credit union difference, credit cards can still be a credit union's highest-yielding asset.

This white paper for the CUNA OpSS Council specifically discusses:

• Significant CARD Act provisions and pricing implications
• Effective pricing strategies
• Credit union advantages
• Metrics
• Marketplace forecasts

It also includes three case studies showing how credit unions' pricing has evolved to fit today's marketplace.

CUNA Council members are entitled to complimentary copies of these and more than 200 white papers; non-members may purchase the white papers for a price of $50 per copy.

The paper is available online in the white paper section of each council site – select the “OpSS” tab.

Regulatory Comment Calls & a Final Rule Analysis

CUNA
August 19, 2010

COMMENT CALLS:

NCUA Proposed Rule on Golden Parachute and Indemnification Payments

The National Credit Union Administration (NCUA) Board has issued a proposed rule for comments on prohibited golden parachute and indemnification payments for all federally insured credit unions (FICUs), including both natural person and corporate credit unions.  Under the proposed rule, FICUs, regardless of their financial condition, may not make indemnification payments to an institution-affiliated party (IAP) for legal and other professional expenses in administrative and civil proceedings by NCUA or a state regulatory agency where the IAP is assessed a civil money penalty, removed from office or made subject to a cease and desist order.  IAPs are defined under section 206(r) of the Federal Credit Union Act (FCU Act) and include a committee member, director, officer, or employee of or agent for an insured credit union and certain consultants and independent contractors that have knowingly violated a law or regulation and caused a financial loss to the credit union.

In addition, FICUs may not generally make golden parachute payments to an IAP if the FICU is: insolvent, in conservatorship, rated CAMEL 4 or 5, or in an otherwise troubled condition.  A credit union that has received assistance under sections 208 or 216 of the FCU Act would be considered in a ‘‘troubled condition.'' 

> View Full Comment Call at CUNA.org

Interim Final Rule: Low-Income Definition

The National Credit Union Administration recently adopted an interim final rule.  NCUA amended the definition of "low-income members" to clarify that, in determining a credit union's low-income designation, the comparison of credit union data (whether individual or family data) must utilize statistical data in the same category.  This means, for example, an individual's income must be compared to median individual income and not to median family income.  Comments are due to CUNA on September 20, 2011 and due to NCUA on October 4, 2011.

> View Full Comment Call at CUNA.org

NCUA Interim Final Rule Clarifies Regulation DD Overdraft Protection Rules

The National Credit Union Administration has issued an interim final rule that clarifies the recent final rules amending Regulation DD, the Truth in Savings Act, that changed the disclosure requirements for overdraft protection plans.

> View Full Comment Call at CUNA.org

Interim Final Rule that Extends the Effective Date for Certain Provisions of the CARD Act Gift Card Rules

The Federal Reserve Board has issued an interim final rule that implements an amendment to the Credit Card Accountability, Responsibility and Disclosure Act of 2009 (CARD Act) that was signed by President Obama on July 27, 2010.  This amendment delays the August 22, 2010 effective date of certain provisions of the CARD Act rules that impose restrictions on the fees and expiration dates for gift certificates, store gift cards, and general-use prepaid cards.

> View Full Comment Call at CUNA.org

 

FINAL RULE ANALYSIS:

Fed Adjusts the Amount of Mortgage Fees that Trigger Additional Disclosures Under Truth in Lending

The Federal Reserve Board has announced its annual adjustment of the dollar amount of points and fees that trigger additional disclosures and prohibitions under the Truth in Lending Act for certain mortgage loans.  The dollar amount will be adjusted from $579 for 2010 to $592 for 2011, which is based on the Consumer Price Index.  More info:

> View Full Final Rule Analysis at CUNA.org

 

> Regulatory & Legislative Resources for Council Members