The deposit market can be conveniently divided into retail and wholesale segments, although the boundar y between these two segments has became somewhat blurred by the increase in the numbers of the “mass affluent”. The retail and wholesale segments have very different characteristics. Retail deposits can be broadly characterized by the following:
Priced by banks. Retail deposits are priced on the basis of rates published by individual banks. These rates can be changed at will and retail depositors’ only choice is to accept those rates or take their deposits elsewhere.
Rates on retail deposits offered by banks in most countries have been highly regulated in the past and in many countries continue to be set centrally. In some countries regulators determine these rates, while in others they are set by individual banks acting as a cartel. The global trend over the past two decades has been towards de-regulation and liberalization.
Relatively sticky. Retail customers do not switch banks very often. There is a high degree of iner tia. This can be explained by the relatively high switching costs that are entailed with, for example, moving standing instructions to pay regular bills automatically from an account at one bank to an account at another bank.
These switching costs act as an impediment to competition and in some countries lawmakers have introduced legislation to require banks to transfer details of standing instructions set up for a customer at one bank to another bank when instructed to do so by the customer.
Relatively price insensitive. Most retail depositors do not move their deposits from one bank to another for the sake of an extra 50 basis points (bpts). The degree of price insensitivity depends partly on the size of the deposits and partly on the reason why the customer has made the deposit. A customer using an account primarily as a transaction account will be less price sensitive than a customer using the deposit account as a savings account or as a means to generate an ongoing income.
Location and convenience. Attracted on the basis of location, convenience and branding. The number and geographic spread of branches, opening hours, and access to automated teller machines (ATMs) are of particular impor tance.
High administrative costs. Can be relatively expensive in terms of operating costs per dollar of deposit, particularly if depositors make frequent, small deposits and withdrawals.
Wholesale deposits can be characterized by the following:
Prices set by supply and demand. Wholesale deposit rates are largely set by supply and demand and are usually priced against a market rate such as the three-month interbank rate. Wholesale depositors may be able to negotiate for better rates by threatening to move their deposits to another bank.
Very mobile. Wholesale deposits can be switched from one bank to another by means of electronic instruction.
Highly price sensitive. An extra 10 bpts on a $100m deposit is wor th $100 000 on a one- year deposit.
Highly counterparty credit quality sensitive. Wholesale depositors are conscious of their counter party risk and manage it actively. At the first sign of any real problems, or even perception of problems, at a bank wholesale depositors will switch their funds to other banks perceived as lower risk.
Low administrative costs. They are very low cost per dollar to administer, and involve limited human inter vention.
Most commercial banks take both retail and wholesale deposits. They do have to make a strategic decision on competitive positioning. The choice is between maintaining a (relatively) large, expensive distribution network and attracting cheaper retail deposits and operating with a smaller number of branches, at relatively low cost, and rely on more expensive, higher risk wholesale deposits.
There has been a global trend towards the liberalization of deposit products. In many countries restrictions on regulated accounts have included the following:
Demand deposit accounts. An account on which US banks are not allowed to pay interest on any outstanding balance.
Savings accounts. A retail account offering a fixed rate of return. Notice of withdrawal normally has to be given above a minimum prespecified limit.
Time deposits. Deposits with a fixed rate and fixed term. Early withdrawal is usually subject to a penalty fee or may even be prohibited.
NOW deposits. A US deposit account (negotiable order of withdrawal account). One of the first US bank deposit accounts on which interest rates were deregulated.
The original objective of regulating the rates that banks could pay on deposits was to eliminate what was perceived as potentially dangerous, destabilizing price competition.
The reasoning being that some banks would bid up deposit rates to attract funds but then have to make higher-risk, high-yield loans to generate an economic return. Other banks would then be forced to match those rates to keep their own deposit base intact leading to a spiraling crisis. Ignorant retail depositors would not understand the higher risks they were accepting in return for the higher rates and would go to the bank with the highest rates.
There is some evidence to suppor t this. The Bank of Credit and Commerce International (BCCI), which collapsed in 1991, offered rates that were significantly higher than at other banks. BCCI was widely referred to, in the City of London, by financial professionals as the “Bank of Crooks and Criminals International”, well before it failed. But, many of its predominantly Asian depositors were unaware of its reputation or the risks they were taking and they all lost almost all of their deposits in the aftermath of its failure.