What Are Core Deposits?

Deposits are the most basic source of funds for traditional commercial banks. Although the balance of each deposit account is always changing, for commercial banks in general, a decrease in the balance of one deposit account may be offset by an increase in the balance of another account.

Core deposit

Deposits are the most basic source of funds for traditional commercial banks. Although the balance of each deposit account is always changing, for commercial banks in general, a decrease in the balance of one deposit account may be offset by an increase in the balance of another account.

Chinese name

Core deposit

Foreign name

Core Deposits

Also known as

"Lazy money"

Nature

The stable part of the deposit

Foreign Studies on Core Deposits

1. Stability and long-term nature of core deposit balances

It is generally believed that core deposit balances are not sensitive to interest rates and are therefore relatively stable. Becher (1962), Oi (1962), and Parson (1972) found that setting up a new account by a saver (opening a new account with a bank) would incur a set-up cost that would prompt the bank and the saver to maintain their existing relationship. Although maintaining this relationship may not be optimal for both parties in the short term, it is the optimal choice in the long term. Flannery's (1982) conclusion is similar to the above. He believes that signing a new deposit contract will bring both installation costs and learning costs to both banks and depositors. In order to save capital costs when banks have sufficient funds, they can reduce core deposit balances. However, due to the above costs, coupled with the large amount of funds required in the future, banks are generally unwilling to reduce core deposit balances. The principle is the same for savers. The author believes that core deposits reflect the mutually beneficial relationship between banks and savers: banks are willing to provide various high-quality services to savers for a long time, and savers are also willing to accept deposit income below market interest rates for a long time. This mutually beneficial relationship makes the changes in core deposit balances not change greatly due to changes in the external environment, so the core deposit balances are relatively stable.

Although the core deposit balance is relatively stable, because the core deposit can be withdrawn at any time, it does not have the exact maturity date like a fixed deposit, such as 3 years. Flannery and James (1984) pointed out that because depositors are willing to hold a certain amount of core deposits to meet the daily transaction and to meet the payment needs arising from emergencies, core deposits have longer actual maturity dates. However, they did not indicate the specific maturity date of the core deposits. For commercial banks, only by accurately understanding the term of each source of funds can the funds be reasonably arranged, and the problems of idle or insufficient funds can be avoided. Therefore, it is not enough to study the core deposit balance with a longer actual maturity date. Commercial banks are concerned about whether "longer" is "how long", 3 years or 5 years, or 10 years. Therefore, measuring the actual maturity of the core deposit balance has become a subject for further study by scholars.

In 1993, the American scholar Chambers first gave the actual maturity date of the core deposit balance. His research shows that the average holding period of core deposits is 5 years. Many scholars have also studied this issue after him. Empirical analysis by Morgan and Cates (1994) shows that banks typically lose 50% of their core depositors after 8 years, and after 20 years they will lose all of their core depositors (without considering the addition of new depositors). On average, the holding period of core deposits is 6-8 years. Their research not only gives the actual maturity date of the core deposit balance, but also draws the important conclusion that "the rate at which core deposits die out decreases over time." Research by Berger and Udell (1995) shows that the actual maturity of core deposits is about 12 years, while the empirical result of Pennacchi (1996) is 6 years. Overall, the actual maturity of core deposits is about 6 years. The main reason that Berger and Udell (1995) differ from other scholars is that they choose samples of different properties. After analyzing the composition of the core deposits of the banks they studied, the authors found that the former's research object, that is, the core deposits of the selected banks were mainly personal current deposit accounts, while the latter's research objects were corporate current deposit accounts. Mainly. Due to the large amount of corporate deposits, their sensitivity to interest rates is relatively high, and it is normal for their terms to be shorter than personal demand deposits. From this perspective, although core deposits do not have an exact maturity date, their actual maturity dates are very long. Therefore, for banks, core deposit balances are stable and long-term. At the same time, the divergence of the research conclusions of the above scholars also tells us: When studying the actual maturity of core deposits, we should calculate the actual maturity of different types of core deposits separately, so as to obtain more accurate data.

2. Determinants and characteristics of core deposit interest rates On the surface, core deposit interest rates are set directly by commercial banks. In fact, banks need to consider the response of savers and the state of the market when setting this interest rate. Whitesell (1992) and Huthison (1995) emphasized the importance of savings and transaction functions in core deposit pricing. They believe that the stronger the depositor's willingness to save (corresponding to the willingness to invest), the more the trading function of core deposits, and the lower the interest rate. McGuire (1995) believes that the game between commercial banks and depositors determines the interest rate level of core deposits. The quality and convenience of commercial banks' core deposit supplementary services are the main factors for depositors to consider, and the preferences of depositors determine that commercial banks will set an optimal interest rate under the prevailing market interest rates. After some economic factors change, the original equilibrium will be broken, so a new round of games will be produced, and eventually a Nash equilibrium point of the existing strategy that banks and savers are unwilling to change.

More research has focused on the characteristics of core deposit interest rates. Small (1990), Harman and Berger (1991), Neumark and Sharp (1992), and Ausubel (1992), after analyzing the statistics of Bank of America, pointed out that the core deposit interest rate has three basic characteristics: First, the core deposit interest rate is low The market interest rate (generally refers to the one-year deposit or government bond interest rate); the second is that the core deposit interest rate is sticky in the short term (the core deposit does not immediately respond to the adjustment of the market interest rate, and its adjustment has a certain time lag); the third is from In the long run, the adjustment trend of core deposit interest rates is asymmetric (when the market interest rate rises, the core deposit interest rate does not rise accordingly, showing a rigid feature; when the market interest rate declines, the core deposit interest rate declines with a non-rigid feature). It is easier to understand that the core deposit interest rate is lower than the market interest rate, because core deposits have higher liquidity than one-year deposits and government bonds, so their yields are relatively low. The idea that the core deposit interest rate is sticky in the short term is proposed by O'Brien (2000). He believes that, in theory, after external factors affect market interest rates, the core deposit interest rate should change accordingly. But in fact, if the market interest rate rises, the bank raises the core deposit interest rate, which will increase interest expenses. In order to control costs, banks will reduce the quality of core depositors' services and reduce the number of services. Savers are also aware that if the interest income from deposits increases, it will be impossible to enjoy the original high-quality services and the convenience will be reduced, so savers are willing to accept the original interest rate. As banks and savers are reluctant to change their original strategies, core deposit rates will not rise in the short term. By the same token, if the market interest rate drops, banks and savers will still adopt the original strategy, and the core deposit interest rate will not fall accordingly. Therefore, from the actual situation, banks will not adjust core deposit rates frequently because of changes in market interest rates. Core deposit rates are sticky in the short term. But in the long run, the core deposit interest rate has the characteristics of asymmetric adjustment. Ausubel (1992) believes that limited information and the existence of search costs are the main reasons for the asymmetric adjustment of core deposit interest rates. The conclusion of its model is that when the market interest rate continues to fall, the probability of losing core deposits of commercial banks is also very large. The actual situation is that in the long run, when market interest rates continue to rise, savers are constantly turning core deposits to other investment vehicles due to the temptation of high interest rates. Sharpe (1997) explained the asymmetry of the core deposit interest rate adjustment based on the modeling of consumer search costs, but he did not propose a clear solution. Kahn et al. (1999) attempted to explain the adjustment of the deposit interest rate by using the limited memory of consumers, but they still failed to clearly explain why the core deposit interest rate would be asymmetrically adjusted when the market interest rate rises and falls. To this day, no scholar can reasonably explain this problem.

3. Valuation methods and premium characteristics of core deposits Foreign financial institutions generally tend to use quantitative models in the pricing and risk prediction and prevention management of financial products. However, the quantitative analysis of core deposits does not have a standard model similar to the Capital Asset Pricing Model (CAPM), mainly because the core deposits lack a highly liquid secondary market. Ausubel (1991), Calera and Mester (1995) and Hutchison and Pennaechi (1996) found through research that the core deposits are difficult to value because market competition is incomplete and commercial banks generally do not sell their core deposits to other banks. At the same time, search and conversion costs, regulatory barriers, and adverse selection issues also make the valuation of core deposits more difficult.