Banks and Credit Unions Must Rethink Deposit Pricing Strategies

Originally Published on The Financial Brand | Traditional ‘cost-of-funds’ pricing model doesn’t cut it anymore. Today’s interest rate picture dictates more reliance on broader ‘cost-of-deposits’ pricing philosophy. Here’s how to shift into this new thinking to build greater profitability.


The Federal Reserve raised rates four times last year, making it nine total adjustments over the past three years, when the Fed first began raising rates from near zero. Despite favorable economic indicators and a strengthening economy, these rising rates, coupled with ultra-competitive loan markets, created more margin compression for community banks and credit unions. That was 2018.

This year, while the Fed says it plans to slow down rate hikes, there still remains uncertainty on the rate environment over the next 12 months. Regardless of the environment, community financial institutions still need to evaluate core deposits to determine how best to spur growth and profitability. With a highly flexible strategy, banks and credit unions can battle margin compression despite ongoing economic volatility.

Dangers of Driving Solely by ‘Cost of Funds’ Thinking

Anyone who went to banking school likely learned the acronym “COF” on their very first day — and for good reason. Without a sharp eye on cost of funds (COF), banks and credit unions can expose themselves to interest rate risk (among many other pitfalls), with detrimental long-term effects likely.

If the 2008 financial crisis taught the industry anything, it is that net interest margins can compress quickly — and stay compressed much longer than anyone expects or most models predict. These periods of extended margin compression revealed how little control institutions have over their return on earning assets versus market forces. That said, there remains significant opportunity on the deposit side that ultimately enables greater control of that critical margin.

“Basing strategic funding decisions on cost of funds analysis alone is like driving down the highway with blinders on.”

Unfortunately, COF will always fall short when assessing the true cost for the most common deposit products in a bank or credit union today: checking accounts. This remains the core component of any consumer’s relationship with their primary financial institution, and the most likely means for attracting new relationships, which are vital for long-term sustainability.

For instance, a group of qualification-based, high-interest checking accounts at one institution has a median of $9.76 in monthly interest expense, which translates to a COF of 2.11%. That is high enough to send any CFO running, but those same accounts generate a median of $28.31 in monthly net non-interest income (NII). A complete examination reveals these accounts generate $39.25 in median marginal profit per account (monthly).

Clearly, basing strategic funding decisions on COF alone is like driving down the highway with blinders on, leaving you in danger of making a costly mistake.