Magazine article American Banker

Don't Let Low Rates Fool You into Closing Valuable Branches

Magazine article American Banker

Don't Let Low Rates Fool You into Closing Valuable Branches

Article excerpt

In today's low rate environment, branches are being closed and others opened on the basis of mathematically accurate formulas that yield the wrong decision for the long run.

I am talking about transfer pricing, that methodology (some say art) by which CFOs and treasurers allocate interest expense to loans and interest yield to deposits. The purpose is to ensure that management has a solid understanding of the profitability ramifications of its decisions.

Transfer pricing can turn a silk purse into a sow's ear in an instant, since every 10 basis points of yield or cost make a huge difference in the profitability of the product affected. It dwarfs all other elements in the product profitability equation. Cost allocations are important, but transfer pricing is king.

But four years of stable low rates have wrought havoc in transfer pricing systems everywhere. Deposits have become a much less attractive source of funding than wholesale alternatives. Banks have found it cheaper to borrow than to take deposits. CFOs across the industry started asking themselves, "Who needs deposits when FHLB advances are so much cheaper?"

Some banks also discovered the only limitation of no-interest checking accounts: You can't go below zero on the pricing. In fact, free checking balances turned from highly attractive to ho-hum for many banks. Some realized that zero is really a fixed-rate price. The value of interest-free deposits is dramatically lower with Fed funds at 1% than at 4%.

One result of this sea change is that deposits look like huge losers. No branch can seem to make money when its transfer-priced interest income is a negative number.

Though everyone knows this is temporary, it seems less so every day. The heads of retail banking in most banks are frustrated with the poor financial results their business yields, and many have abdicated their high-cost deposits, such as CDs, to rate-surfing institutions and Internet banks. …

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