NOTES FOR DEPOSITS MANAGEMENT AND

PRICING
Introduction

The bank role in the economy is to pool/collect deposits and extent/grant/give loans.

The role of the bank is intermediary: transform/convert deposits into loans and other income-earning
assets and non-income earning assets (these assets earn income for the bank: loans, financial securities)

Deposits are very important for the bank. Without deposits, the bank cannot give loans. The Bank need
to attract deposits. It needs to encourage “people and firms” (savers) to deposit their money with the
bank

Deposits (purchased funds) are the main source of loans

The bank wants to maximise profit

Net income = operating income – operating expenses – LLP

Net income = (interest income + net noninterest income) – (interest expense + noninterest expense) - LLP

To increase net income, we need to the following

i. Increase Interest income  increase loans, or increase interest rates on loans

ii. Increase noninterest income
iii. Decrease interest expenses  reduce interest rate on deposits
iv. Decrease non-interest expenses
v. Decrease LLP

On the quantity/volume/dollar value side:

Increase profit  increase interest income  increase quantity of loans  increase quantity of deposits

“WITHOUT DEPOSITS YOU CANNOT GIVE LOANS = YOU CANNOT HAVE INTEREST INCOME WITHOUT INTEREST
EXPENSE”
Example

In t=0, the bank has deposits of $1,000,000, loans are $1,000,000. Interest rate on loans is 10%, interest rate in
deposit is 6%

Spread = interest margin = 10% - 6% = 4%

The bank wants to attract more deposits to make more loans. How?

- Increase interest rate on deposit

- Spread = interest margin = 10% - 8% = 2%
- Spread = interest margin = 12% - 8% = 4%

A Dilemma:

If you increase interest rate on deposits, you will attract more deposits, but spread (profit) will go down

If you increase deposit rate and increase the interest rate on loans to keep the same level of spread (profit), loans
will go down, profit will go down

Price competition / nonprice competition

A shop sells phone: Buys a phone from the wholesaler at purchase price of AED1,000 and sell it at retail price of
AED1,200  Profit = AED1,200 – AED1,000 = AED200

AED1,200 = AED 1,000 + AED200

Selling price = cost of buying phone + profit margin

Cost of buying the phone = AED1,000

Actually he bought the phone from the supplier at AED800, cost of labour was AED50, cost of transport was
AED50, other expenses (rent) is AED100  cost of buying the phone = AED800+ AED50 + AED50 + AED100 =
AED1,000

The bank buys a deposit at the deposit interest rate (6%) and sells this deposit in the form of loans at the interest
rate on loans (10%)

Spread = profit = 10% - 6% = 4%

Interest rate on loan = interest rate on deposits + profit margin

Interest rate on deposit 6%= core rate 3% + 1% labour organising collection of deposits + 2% other costs related to
deposits
1. Types of deposits:

Two types of deposits:

Demand deposits (transactions deposits; transactions means = buying and selling and paying = can be used any
time = withdrawn without penalty

Time deposits = term (non- transaction deposits = they cannot be used any time = cannot be withdrawn without
penalty) = People use these account to save money at interest rate (these deposits are interest income-earning for
savers)

Instruments (tools) of payment = cheques books and debt card

Credit card is a loan which you use “a card to use”

Demand deposits Time deposits or term deposit or

nontransaction deposit
Current account Saving deposits Fixed deposits
(Checking)
Source Individuals, firms, gov
Number of Unlimited Allowed to Blocked for a
times of (anytime) within withdraw a limited period
withdrawal the limit of the limited times or very limited.
(how frequent) amount per period (2 If someone
Anytime 1000 times per wants to
month). Third withdraw, there
time will be is a penalty 0
with a penalty
Size of the Any size, within Size may limited
withdrawal the amount
Maturity People can San open many Different
open as many maturities: 1
account they year , 2 years or
want years XXX
Does it pay NO Yes, but low YES
Interest?
Tools of Chequebook/ Chequebook One Payment to
withdraws Debit card/ the account
online
payment
Usability For transactions Interest-earning
saving
Min/max No Yes/No Yes
The bank would prefer demand deposits because they are associated with 0% or low interest rates. However, the
bank needs to keep liquidity to meet withdrawal.

In terms of stability of deposits, term or time deposits will be better, but they come with higher interest rates 
less spread

10,000, 12% per year

12% / 12 =1% 

Composition of deposits

Meshreq Bank
2019 2018 2017 2016 2015 2015-2019
Demand Deposits 8,844.96 9,092.78 11,193.81 11,177.32 10,574.17
Savings And Other 11,965.42 10,651.10 7,696.39 7,866.66 7,188.86
Time Deposits
Unspecified Deposits 3,955.54 2,912.15 1,819.01 1,931.26 2,284.64
Total Deposits 24,765.92 22,656.03 20,709.21 20,975.25 20,047.66

Interest Expense on 462.05 377.53 241.06 234.55 165.62

Bank Deposits

Cost of deposits = 1.87% 1.67% 1.16% 1.12% 0.83% 1.36%

interest expense / total
deposit

Total Deposits have increased from $20bn in2015 to $25bn in 2019. Which as responsible for this increase?

Composition = structure of deposits

2019 2018 2017 2016 2015 2015-2019
Demand Deposits 36% 40% 54% 53% 53% 47%
Term deposits: Savings 48% 47% 37% 38% 36% 42%
And Time Deposits
Unspecified Deposits 16% 13% 9% 9% 11% 12%
Total Deposits 100% 100% 100% 100% 100% 100%

Meshreq Bank  main deposit type over the 2015-2019 is demand deposits 

Interest rates on deposits are low because the largest type of deposits is demand deposit (which is associated with
no or very low interest rate)

Meshreq Bank buys Tomato at AED1  2.0

Trader B buys tomato at AED3  3.1

Bank of Sharjah

2019 2018 2017 2016 2015 2015-2019

Demand Deposits 803.83 1,018.9 1,360.69 1,091.3 1,155.03 5,429.78
(transaction) 2 1
Savings And Other Time 4,673.56 4,870.4 4,012.94 4,215.4 3,691.37 21,463.74
Deposits 2 6
(nontransaction/store of value)
Total Deposits 5,477.39 5,889.3 5,373.65 5,306.7 4,846.39 26,893.54
4 7
           
Interest Expense on Bank 167.85 152.96 126.27 119.45 135.67 702.19
Deposits

Interest rate on deposit = 3.06% 2.60% 2.35% 2.25% 2.80% 2.61%

interest expenses on deposits /
total deposit

2019 2018 2017 2016 2015 2015-2019

Demand Deposits 15% 17% 25% 21% 24% 20%
Savings And Other Time 85% 83% 75% 79% 76% 80%
Deposits
Total Deposits 100% 100% 100% 100% 100% 100%

Interest rate are high because the largest type of deposit is saving and time deposit (which is associated with
higher interest rate)

Structure of the UAE per sector: (demand and saving and time deposits = private sector = people and firms)

2015 2016 2017 2018 2019

Demand 398,543 411,792 424,656 415,165 436,573

savings and 729,523 750,920 783,296 822,210 896,045
time
 Government 155,613 185,036 210,007 288,422 301,737

Total 1,283,67 1,347,74 1,417,95 1,525,79 1,634,35

9 8 9 7 5

2015 2016 2017 2018 2019

Demand 31.0% 30.6% 29.9% 27.2% 26.7%

savings and 56.8% 55.7% 55.2% 53.9% 54.8%

time
Government 12.1% 13.7% 14.8% 18.9% 18.5%

Total 100.0% 100.0% 100.0% 100.0% 100.0%

Managers of depository institutions would prefer to sell only the cheapest deposits to the public but it is
predominantly public preference that determines which types of deposits will be created

Overdraft Facility: a loan available to account holders for limited period in which they can make
their balance negative for the amount of the “overdraft”. If someone passes the deadline of
returning it the money back, there will be a fee (or as well interest rates)

On conditions of AED 8,000 minimum salary transfer required

Every month, the account holder must have a minimum balance, AED3,000 for example. Otherwise, the bank will
charge a fee of AED25 (this fee is considered non-interest income for the bank)

Why does the bank charge such a condition and fee?

- The bank wants to have a stable “cost” deposits. There is a minimum amount, all the times so the bank
can lend this “core” deposits
- The bank can make a minimum amount of loans: AED3,000 loan per deposit account.
- We deposit our money with the bank for safety: the bank is protecting the money for us, the bank has
spent money to print chequebook, issue a plastic card (paper and ink)
o To main he account, the bank spends money in operating expenses. So sometimes the bank
imposes a fee.

For savings account, the bank will give interest on your savings. Correct. But t the bank, might charge you a fee or
maintain the account.
Conditional pricing = fees are paid when the account holder meet the criteria of the schedule)

- Pricing schedule = menu

Where a bank sets up a “schedule of fees”:

Conditional pricing techniques vary deposit prices based on one or more of these factors:

Relationship-based pricing

Banks develop relationship with their customers (depositors and borrowers)

Related to the idea of targeting the best customers for special treatment is the notion of pricing deposits according
to the number of services the customer uses

Customers who purchase two or more services may be granted lower deposit fees compared to the fees charged
customers having only a limited relationship to the offering institution

In theory, relationship pricing promotes greater customer loyalty and makes the customer less sensitive to the
prices posted on services offered by competing financial firms

COST PLUS pricing

Pricing and setting interest rates

• In pricing deposit services, management is caught in a dilemma

• It needs to pay a high enough interest rate to attract and hold customer funds, but must avoid
paying an interest rate so costly it erodes any potential net interest margin

AED 25 = operating and overheads expenses + profit margin

For Bank to maintain its basic transaction account, which requires a AED3,000
minimum balance, the bank incurs the following costs:
- An average of AED6.50 per month in servicing costs (including labour and
computer time: salaries)
- AED5.50 per month in overhead expenses (rent, Dewa)
- The bank maintain a profit margin per account of AED3.50 per month profit
margin on these accounts.

fee = AED6.50 + AED5.50 + AED3.50 = AED15.50

be: 
Unit price charged the = Operating expense + Estimated overhead expense + Planned profit
customer for each per unit of deposit allocated to the deposit- margin from each
deposit service service service function service unit sold
 

Question

New Day Bank plans to launch a new deposit campaign next week in hopes of bringing in from $100
million to $600 million in new deposit money, which it expects to invest at a 4.25 percent yield (the
interest rate on loan = 4.25%)

Management believes that:

- To attract $100 million in new deposits, they need to offer the rate of 2%.
- To attract $200 million, the bank needs to offer 2.25 percent.
- To attract $300 million, the bank needs to offer 2.50 percent,
- To attract $400 million, the bank needs to offer 2.75 percent,
- To attract $500 million, the bank needs to offer 3.00 percent,
- To attract $600 million, the bank needs to offer 3.25 percent.
What volume of deposits should the institution try to attract to ensure that marginal cost does not
exceed marginal revenue?
Interest rate on loans = marginal interest rate = 4.25%
MR = AR =4.25%

Expecte Offered Total Marginal Marginal Interest Interest Profit Marginal Marginal
d flow in rate interest cost cost rate rate on revenue = profit profit in
cost (for the loans = = revenue percent
extra marginal - cost
100mn) interest
rate on
loans
$100 2% $100 X $2 2% 4.25% 4.25% $4.25 - $2.25 2.25/(100-
2% = X $100 $$2 = 0) =
$2 = $4.25 $2.25 2.25%
$200 2.25% $200 X (4.5 – 2) $2.5 / 4.25% 4.25% $8.50 - ($4.00 - $1.75 /
2.25% = $2.50 (200 – X $200 $4.50 = $2.25) = (200 –
= $4.50 100) = = $8.50 $4.00 $1.75 100) =
2.5% 1.75%
$300 2.50% $300 X ($7.50 - $3.00 / 4.25% 4.25% $12.75 ($5.25 - $1.25 /
2.50% $4.50) = (300 – X $300 - $7.50 $4.00) = (300-200
= $7.50 $3.00 200) = = = $5.25 $1.25 = 1.25%
3.00% $12.75
400 2.75% 2.75% $11.0 - $3.50/ 4.25% 4.25% $17 - $6 - $0.75 /
X $400 $7.50 = (400-300) X 400 $11 = $5.25 = (400-300)
=$11 $3.50 100 = = $17 $6 $0.75 = 0.75%
3.50%
500 3.00% 3% X ($15 – 4.00/(500- 4.25% 4.25% $21.25 $6.25 - $0.25/
$500 = 11) = $4 400) = X $500 - $15 = $6 = (500-400)
$15 4% = $6.25 0.25 = 0.25%
$21.25
600 3.25% 3.25% $19.50 – $4.50/ 4.25% 4.25% $25.50 $6.00 - -0.25 /
X 600 $15.00) (600-500) X 600 – $6.25 = - (600-500)
= = $4.50 = 4.50% = $25.5 $19.50 $0.25 = -0.25%
$19.50 = $6

The ideal deposit and rate for this deposit raising is $500mn at the interest rate of 3%