SmartRamps Commentary, June 2012
What Really is a Stable Deposit?
Last quarter’s commentary examined the implications of Basel III for core deposits. Two
features of the guidance were noted as important. First, the Liquidity Coverage Ratio (LCR)
requires financial institutions subject to Basel III to hold a minimum of 7.5% of their stable
deposits in the form of cash or additional equity. One can interpret the LCR as equivalent to a
standard reserve requirement for deposits. Second, the Net Stable Funding Ratio (NSFR) puts
a premium on stable funding sources that can be used in the long term to partly offset required
stable funding uses and offset capital requirements.
Most financial institutions in the US will not be subject to the provisions of Basel III. Some of
them may thus find it tempting to discount its importance. Even if an institution is not subject to
the full implementation of Basel III, understanding how the NSFR rule works and its implications
for liquidity and capital requirements will be important. In other words, an institution may not be
explicitly subject to NSFR but knowing what that regulation implies will allow management to
better manage risk.
Underlying Basel III is a major unaddressed issue, a terminological issue really, relating to “core
deposits,” “nonmaturity deposits,” and “stable funding sources.” From an individual financial
institution’s perspective, there are two important questions. First, is there any difference
between these three terms? The answer to that is “maybe.” And second, what specific
categories of deposits are eligible to fit under the different labels?
To answer the first question, nonmaturity deposits are the simplest to define. They include any
deposit class that has no contractually stated maturity – balances can be withdrawn1 at any time
without penalty. Core deposits are defined a bit more ambiguously. They are types of deposits
central to the bank’s deposit-taking mission. Stable funding sources is the most ambiguous –
they are not explicitly defined in Basel III at all. Presumably they include any liability whose
supply is not expected to adversely change appreciably over time.
So what types of US deposits fit under the different labels? Nonmaturity deposits would
presumably include checking accounts, savings accounts, and money market accounts, while
excluding CDs. Core deposits would presumably include traditional checking accounts and
savings accounts without question. The case for ‘hotter money” money market accounts might
be open to question, although money market funds were established in 1971 initially as a
substitute for checking accounts and money market accounts carry a check writing capability.
Stable deposits would presumably include only non-rate value oriented checking and savings
accounts that have remained stable over time.
1
Many US nonmaturity deposits except DDA have contractual restrictions on the full withdrawal of funds.
These are rarely, if ever imposed, however.
2012 McGuire Performance Solutions, Inc.
1 But the key word in the prior paragraph is presumably. Some institutions will have accounts in
checking deposits that vary tremendously; other institutions will have accounts in money market
accounts (or even CD’s) that are remarkably stable. The implication is that what type of
deposits fall into which Basel III category is not something that can be addressed strictly on
theoretical grounds. It must be addressed primarily on empirical grounds. That point needs to
be emphasized. Core deposits are nonmaturity deposits, but may or may not be stable funding
sources. This is not recognized in the official record - Basel III does not specify the possibility of
differences across financial institutions and the Federal Reserve’s proposed implementation
focuses on Tier 1 capital rather than on stable funding sources.
MPS has examined all types of deposit classes across a wide range of institutions since 1995.
We can make three important general statements based on that experience:
First, behavior of account types with the same name can vary widely across institutions. For
example, the checking category at one institution can have a long-term retention rate of virtually
100 percent for long periods and clearly fit the definition of stable deposits. Yet at another
institution, less than 50 percent of checking category balances remain after only five years. The
determining factor is likely that service, convenience, and product fit are all excellent at the first
institution and poor at the other. Or depositor demographics could be contributing. For money
market categories, the range of retention rates is typically even greater and highly correlated
with tier size.
Second, many institutions have extremely stable core/nonmaturity deposits. It is not atypical to
find checking and savings deposits with average lives well into low double digits at Base Case
(constant current interest rates). Average lives do tend to shorten, however, as interest rates
rise (and vice versa). This must be factored into the stability assessment.
Third, the institution’s pricing behavior will have an impact on the stability of their core deposits.
If an institution chose to compete on features such as service, convenience, and product fit,
rather than on rates paid, changes in interest rates will likely have a limited impact on deposit
stability because the financial component of supply motivation is low. In contrast, if an institution
competes on rates paid, a change in interest rates may also have a limited impact on deposit
stability, but it will have a significant impact on interest expense and possibly earnings. In the
former case stability is created while in the latter case it is bought. Surely that distinction needs
to be considered in defining stable deposits!
While for most US institutions Basel III will not have a direct impact, understanding what defines
and drives stable deposits is critical for managing risk and in maximizing earnings. The solution
is to quantify historic behaviors – the only guide to noncontractual behaviors in the future – at
high levels of accuracy. Statistical methodologies to do this have been proven successful in
many applications, across several charter types. Now is the time to consider such a study for
your institution.
Richard G. Sheehan, Ph.D.
Senior Vice President, Research
2012 McGuire Performance Solutions, Inc.
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