Banks aren’t just piggy banks in suits. They’re financial jugglers trying to balance paying you just enough interest so you hand over your $($money$)$—but not so much that they end up broke. So how do they decide what to offer you on your $($savings$)$? Enter: deposit pricing.
Let’s explore the main methods banks use to price deposits, and why knowing them is key to understanding both bank profitability and your account fees.
🧱 Foundation First: Deposit Types and Their Rates
The rate offered depends heavily on the type of deposit:
- Transaction deposits $($e.g., checking accounts$)$
- Nontransaction deposits $($e.g., savings, CDs$)$
The longer the bank can keep your money, the more interest they’re willing to pay. So:
- CDs > MMDAs > Interest-bearing checking
- Big banks usually pay less than smaller banks
- Core deposits $($checking, savings, time deposits$)$ are stable and cheap
Why care? Because understanding deposit types explains why pricing varies—and sets the stage for how banks determine how much to pay you.
💸 Cost of Deposits: Not All Dollars Are Equal
Demand $($transaction$)$ accounts are usually cheapest for banks.
Why?
- Low interest
- Low tech costs $($thanks to online banking$)$
- High fee potential $($think: overdrafts, ATM fees, etc.$)$
But banks can’t survive on “thank you” alone. They need deposit pricing models to ensure profitability. Let’s look at three key ones.
🧾 1. Cost-Plus Pricing – Like Building a Sandwich
Imagine you’re making a sandwich:
- Bread = Operating cost
- Fillings = Overhead
- Sauce = Profit
The cost-plus formula is: Price to customer=Operating cost+Overhead+Profit margin\text{Price to customer} = \text{Operating cost} + \text{Overhead} + \text{Profit margin}Price to customer=Operating cost+Overhead+Profit margin
Example:
A bank’s monthly cost to service an account = \$2.50
Allocated overhead = \$1.25
Profit margin = \$0.25
Total fee = \$2.50 + \$1.25 + \$0.25 = $4.00/month
But wait—what if interest rates change tomorrow? Do we still stick with $4?
This leads us to a more dynamic method…
📈 2. Marginal Cost Pricing – The “What’s It Cost to Add More?” Logic
Instead of asking “What have we spent?”, marginal cost pricing asks:
What will it cost us to raise one more dollar?
The formula: $\text{Marginal cost} = \left( \text{New rate} \times \text{New amount} \right) – \left( \text{Old rate} \times \text{Old amount} \right)$
$\text{Marginal cost rate} = \frac{\text{Change in total cost}}{\text{Additional funds raised}}$
Example:
- Raise \$100M at 5% → \$5M interest
- Raise \$150M at 6% → \$9M interest
- Change in cost = \$2M over \$50M → 8.5% marginal cost
Now suppose loans yield 8%:
- If marginal cost $<$ 8% → Profit
- If marginal cost $>$ 8% → Nope, don’t take more deposits!
This method helps banks know when it’s time to stop chasing deposits.
🏦 3. Conditional Pricing – The “Terms and Conditions Apply” Model
Conditional pricing is like a gym membership:
- Use it wisely, and it’s free
- Use it badly, and they hit you with fees
Pricing depends on:
- Balance levels
- Number of transactions
- Account activity
Types:
- Flat pricing: $3/month, no matter what
- Free pricing: $0/month—but no interest
- Conditionally free: Free if you keep $($say$)$ \$1,000 in the account
Example:
Bank A $($affluent area$)$:
- $>$ \$1,000 → No fee
- \$500–1,000 → \$3/month
- <\$500 →\$5/month
Bank B $($college zone$)$:
- $>$ \$300 → No fee
- <\$300 → \$2/month + \$0.10 per ATM use
These fee structures aren’t random—they reflect customer targeting.
🤝 Bonus: Relationship Pricing – Friends with Benefits
You’ve got a \$500,000 mortgage and a \$100,000 deposit? Your bank loves you.
Relationship pricing links:
- Loans
- Deposits
- Treasury services
So that:
- Big clients get fee waivers
- Loyal clients get better CD rates
- Everyone feels special
Why now this matters?
Because relationship pricing cross-subsidizes services—cut here, profit there.
🔍 Summary: Each Method Has Its Moment
| Method | Strength | Weakness |
|---|---|---|
| Cost-Plus | Predictable, full cost coverage | Ignores market changes |
| Marginal Cost | Responsive, smart capital allocation | Requires complex tracking |
| Conditional | Behaviorally driven, customer-segmented | Can be confusing or feel unfair to users |
Banks use these to not just price deposits—but to signal value, drive retention, and fund the balance sheet at optimal cost.
Next time you see a “Free Checking” sign—ask: Is it really free, or am I just the product?