Deposits vs. Investments Time to Settle This Debate: New Study Puts Some Numbers to the Matter of Disintermediation, Which Should Help Defuse a Long-Simmering Dispute

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Ever since banks and savings institutions began selling mutual funds and annuities in the early 1980s, there has been tension between the advocates of transforming the bank branch into a financial services store and the executives responsible for the traditional core business of banking--collecting deposits and making loans. By selling investments a bank is essentially converting some spread income from deposits into fee income. Alarmists in the traditional banking camp argue that by selling investments a bank could disintermediate itself out of existence.

Advocates of the "bank as a financial services company" counter that the bank's customers need alternative investments, and in fact will buy the investments from some other source if the bank does not offer them. Since the bank's competitors are selling investments, by eschewing investment sales the bank is ceding its customers' investment business to another bank or securities firm that is also offering banking services like loans and federally insured deposits. By letting customers establish relationships with competitors that also provide banking services, the bank is not just at risk of losing some deposits, but is placing its whole customer relationship at risk.

Also, many banks have been trying to diversify away from the spread business. By building up their fee business, banks can insulate themselves more from cyclical loan demand. Indeed, many analysts will downgrade a bank's stock if the bank has less fee income than its peers. But the problem is that the fee income is earned in many cases by cannibalizing the bank's own deposits. Thus, instead of a bank augmenting its spread income with some fee income, the fee income in fact is cutting into the spread income. Deposit products and investment products compete for some of the same dollars.

The advocates of investment sales argue that even though some investment sales cannibalize deposits, the commissions on mutual fund and annuity sales are much larger than the spread income on deposits. But the deposit guardians point out that this spread is earned year after year.

Despite this internal conflict, about half of the banks participating in the annual bank brokerage surveys conducted by Kehrer-LIMRA actively try to convert maturing certificates of deposit into investment sales. But this activity does seem to be cyclical, rising during periods of slack loan demand and shrinking when banks are more fully loaned up. These annual surveys (the Kehrer-ENSI Financial Institution Investment Program Benchmarking Survey) also indicate that many banks are not particularly concerned with disintermediation. In 2006 63% of the banks reported that they provide customer lists to the bank's brokers. And 48% do not even monitor the extent to which investment sales cannibalize deposits.

Ups and downs of disintermediation

The annual Kehrer-ENSI Financial Institution Investment Program Benchmarking Study has measured the extent of disintermediation since 1991. The 2005 study covered 84 banks, credit unions, and third party brokerages that collectively accounted for over half of all bank mutual fund and annuity sales.

The benchmarking data indicate that in 2005 34% of the funds used to purchase an investment in a typical bank were drawn on that bank's interest-bearing deposits.

Over the years, we have observed a general downward trend in this statistic. In the mid 1980s, when S&Ls were just beginning to sell annuities, it was common for institutions to report that 80% of the dollars used to purchase investments came from their own deposits. By the time we began systematically measuring disintermediation, the average bank reported that 60% of the investment sales were funded by their own deposits. This statistic generally declined year by year, reaching a low of 30% in 1999, as deposits were leaving banks in droves, before moving back up after 9-11 to 44% in 2003, as assets rushed back into the safe harbor of bank deposits. …