“Hey First National Bank, If You’ve Got all that Money…

…don’t build a new branch, just pay me a higher interest rate!!” 

 I’ve heard this statement a few times since First National Bank announced it will be building a new branch on Trenton Avenue in Findlay.  On the surface, it’s a fair question and there is logic behind the question that might go something like this: “It takes a lot of money to expand and build a new building.  First National Bank is building a new building so they must have a lot of money.  Wait a minute, if they have all that money, why don’t they just raise my rates so I can actually make something on my deposits?  Typical bankers!”

 This is a logical question, but it is missing a key ingredient that explains why we’re building and not paying higher interest rates: supply and demand.  The interest we pay on CD’s and deposits has a direct correlation to supply and demand.  If we have a large demand for loans—in other words people and small businesses are growing and need financing—we also need to have deposits so that we have funds to loan.  When we need deposits, we pay higher rates to attract those dollars.  At the moment, the Bank (and the rest of the banking industry) does not have a large demand for loans in large part due to the stagnant economy. 

 We also have a huge supply of deposits right now, in large part because people are saving more, spending less, putting their money somewhere safe, and reducing debt.  When we have excess deposits and loan demand is low we can only invest our cash safely at a rate of around .15%.  If we’re only earning .15%, our margin is negligible and doesn’t provide much of an incentive to invest in securities or pay a premium on deposits.  We would just be losing money on those higher paying deposits: not a good way to run any business.  So the short answer to the statement above is that the rates we pay are a reflection of supply and demand and are also reflective of the return we can currently get on our own investments.

 Another point to consider is that the new branch is an investment and a use for the Bank’s cash.  Instead of taking profits to build a branch, we are taking excess cash and investing in buildings instead of loans.  Since the overnight fed funds investments only earn us .15%, and we have plenty of excess cash, we can take some of our dollars and put them into buildings at a relatively low cost considering the alternative is to take those dollars right now and make .15%.  It is a very inexpensive way to grow moderately over the next few years and hopefully generate nice income for our shareholders.  We do anticipate the branch will create additional demand for loans and will eventually put an upward pressure on deposit rates.  So, according to our logic, building a branch should actually cause deposit rates to go up, albeit over a period of time.

 Finally, consider our regulatory burden.  At this point we have no idea how much the Dodd-Frank bill is going to cost us but we do know it will be expensive.  These regulatory costs—and other fixed costs—can be spread over a larger base (with the new branch) and increase our operational efficiency.  Being more efficient is another way for us to save money, allowing us to pass savings on to our customers.  If we do not become more operationally efficient, it will put additional downward pressure on rates because it will be more expensive for us to operate. 

So the 30 second summary of all this is as follows: “Our new branch is an investment in the future.  We currently have the excess cash to invest in our future through construction and hopefully spread our fixed costs over a larger base.  This should allow us to be more competitive in the future as the economy improves.  This will ultimately provide our customer with a better return.  The hope is also to better serve our current customer base with the new location and better serve Findlay and the surrounding area with two branches instead of one.”

FDIC

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3 responses to ““Hey First National Bank, If You’ve Got all that Money…

  1. Bradley J. Yoder, CPA

    Interesting article that answers a great question!

    It wasn’t until a few years ago when I began working on the financial audits of community banks such as FNB Pandora as their external auditor that I truly understood how banking works. I even took a “Money & Banking” class in college!

    There are two ways that banks make money – either by loaning money (the larger of the two) or investing money. Loans are the product that the bank sells. There are two ways that banks can get money to loan or invest – either by borrowing money or by taking on deposits (the larger of the two). Deposits is the cost of the goods that they sell. Essentially, loans are the product that the bank sells, and deposits are the cost of the parts that make up that product. Should Bob who owns Bob’s Hardware Store not open a fourth store, but instead pay more than he needs to pay to purchase his inventory? Should FNB Pandora pay more than they need to pay to purchase their inventory (deposits) to sell in the form of loans?

    Interest rates on deposits at banks really cannot be understood until you understand this concept. Of course, there are two twists in banking:
    1.) The persons with deposit accounts understand themselves to be the customer (and they really still are a customer).
    2.) The person with a deposit account might later be a loan customer.

    However, if you remember that loans are the product that the banks make and deposits are the parts that they buy to make that product, the current interest rate environment for deposits will make much more sense.

    • Community Banker

      Bradley, great comments! Your explanation is a helpful one, especially coming from someone who looks at banking from a different angle.

  2. Rochelle Matthews Stoltzfus

    Thanks for the education!

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