Banks often find it increasingly difficult to manage their liabilities in the low interest rate environment. Dissatisfied with low time deposit and current deposits yields, individuals have shifted their financial assets to mutual funds, which offer higher promised returns. For recent decade, individuals reduced the fraction of their financial resources in bank deposits by 10 percent. Mutual funds, in contrast, grew in quantity for the same period of time. A crucial concern is whether banks will be able to recapture these low rate deposits when interest rates move higher. After the stock market’s significant retreat, many banks found themselves inundated with deposits. Whether this move back to bank deposits as a ”safe haven” is a shift in consumer thinking has yet to be determined.
With the potential high returns that can be earned in stocks and mutual funds, banks find themselves in a highly competitive situation that requires innovative product development, a high level of customer service, and attention to cost controls. Banks began to pursue individual retail customers and are even more aggressive today. Individuals, as a group, are generally not as interest rate sensitive as wholesale customers such as commercial firms and government units, but the attractive returns and ease of access to mutual funds is changing this. If banks can attract consumer deposits, however, these funds are likely to remain on the books for longer periods of time and not move as readily as commercial accounts to other banks when rates change. The objective of banks is to build long-term customer relationships and establish a strong core deposit base.
Liability management plays an important role in the risk-return trade-off at commercial banks. Ever since regulators removed interest rate ceilings on liabilities and expanded the types of deposit products banks could offer, liability management decisions have dramatically influenced a bank’s profitability and risk position. For example, many thrift institutions used brokered deposits to finance extraordinary asset growth.
Liability management decisions affect profitability by determining interest expense on borrowed funds, non-interest expense associated with check handling costs, personnel costs, and non-interest income from fees and deposit service charges. They affect interest rate risk and liquidity risk c. determining the rate sensitivity of liabilities, the stability of deposits toward preventing unanticipated deposit outflows, and the ease of access to purchased funds.
It is reasonable to examine the risk-return characteristics of various bank liabilities, to discuss the appropriate use of average historical costs versus marginal costs and presents a procedure for measuring a bank’s weighted marginal cost of funds. Marginal costs for single sources of funds are then compared with average historical costs for a sample commercial bank. We shall also summarize the relationship between financing events and a bank’s liquidity, credit, and interest rate risk position, describe the changing role and nature of federal deposit insurance.
