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FRBSF

WEEKLY LETTER

January 27, 1989

The California Deposit Rate Mystery
In recent years, a number of journalists and consumer groups have observed that some banks in
California paid lower rates on deposits and
charged higher rates on loans than banks in
other states. These observers have implied that
banking in California may be less competitive
than in other states, insulating California banks
from the market discipline of interest rate competition. In this Letter, we investigate the socalled "California rate mystery."

Which rates?
A number of observers have questioned the rates
California banks pay on money market deposit
accounts (MMDAs), which pay interest and offer
limited checkwriting privileges. But does the rate
mystery extend to other deposits, as well? The
chart shows that for the last five years, the rates
on MMDAs and Super NOWs paid by major
banks in Los Angeles have been lower than the
average rates paid on these accounts by banks in
New York, Chicago, Philadelphia, and Detroit.
Moreover, statistical analysis suggests that these
differences, which have ranged between 50 and
100 basis points over the fivecyear period, are not
due merely to random fluctuations.
California ys. Other Major Markets

Percent

(Average Rates In Four Cities Outside
California Minus Rates In L.A.)

1.5

1.0
Money Market
Deposit Account
~ / ......

/

/',
/'

..... /

........

,'·7
'- ..f.-'

0.5

...............

/

However, the chart also shows that these discrepancies do not extend to rates paid on 2Y2 year
retail certificates of deposit (CDs). Statistical
analysis confirms that from 1984 to 1988, there
has been no significant difference between the
2Y2 year rates in California and elsewhere. The
same finding is true for 6-month CDs.
This suggests that the California deposit rate mystery is confined to accounts that have transactions features. Specifically, MMDAs and Super
NOWs offer depositors checkwriting privileges
and access to automated teller machines (ATMs),
while CDs are more nearly a pure savings vehicle
that offers few extra non-rate features.

Possible suspects
There are two competing explanations of the California rate mystery. One points to certain factors
that may distinguish the California deposit market from other markets. For example, differences
in funding patterns, cost structures, level of bank
services, or consumer preferences may dictate a
different deposit rate structure in California.
The alternative hypothesis suggests that the structure of the California banking market inhibits
interest rate competition. Proponents of this view
argue that California banking is overly concentrated and that banks in the state enjoy significant market power. If this is the case, California
banks would be able to retain deposits and earn
healthy profits without paying "competitive" deposit rates. According to this view, then, changes
in regulations intended to enhance competifion
would reduce concentration and likely would
eliminate the interest rate discrepancies between
markets in California and elsewhere.

0.0
...............\

.

21/2 Year CD

................
.------'-.-------,-----i'----,.-----j -0.5
1984

1985

1986

1987

1988

Source: Bank Rate Monitor

WESTERn BAnKinG

Clues from the data
To determine whether the observed discrepancies in deposit rates are the result of the unique
characteristics of the California deposit market or
the result of market power and noncompetitive

Western Banking is a quarterly review of banking
developments in the Twelfth Federal Reserve District. It is published in the Weekly Letter on the fourth
Friday of January, April, July, and October.

FRBSF
behavior, economists look for evidence in the
data on the deposit rate structure itself, differences in operating expenses, bank profits,
and banking market structure. Looking at retail
deposit rate structure first, it is noteworthy that
the rate differentials between California and the
rest of the country do not exist for CDs. If California banks are using market power to limit interest rate competition in retail accounts, \Ale might
expedthemt() dOso for all types ofacc()unts,
not just the MMDAs and Super NOWs. This line
of reasoning suggests that market power may not
be the rationale for the rate discrepancies.
On the other hand, such a rate structure does not
ruleout the possibility that California banks have
market power only in the markets for MMDAs
and Super NOWs. Because MMDAs and Super
NOWs offer important transactions services like
checkwriting and ATM access, it is possible that
the markets for these two accounts are tied more
closely to a particular locality than are the markets for pure saving vehicles like CDs, which do
not offer location-specific services.
The second piece of evidence, net overhead
margins, suggests that California banks face a
different cost structure than do banks in other
major markets. Overhead expenses are substantially higher in California than in other populous
states and in the
as a whole. This could suggest that California banks, operating in a less
competitive market, are· not forced to operate as
efficiently as are banks elsewhere.

u.s.

However, this cost structure also is consistent
with the view thatCalifornia banks are competing for deposits by offering more services. California banks operate more than 5,000 branch
offices, half of which are run by the five largest
banks. These extensive branch networks are
costly to maintain and operate. California banks
thus may offset lower explicit interest rate expenses with a higher level of non-interest rate,
service expenses. In contrast, many other major
markets (Illinois and New York, for example)
have a tradition of unit banking orrestricted
branching and may not have developed a strong
history of extensive retail customer services.
Third, California banks' profits, after adjusting for
loan losses, have paralleled average profits for
banks elsewhere in the nation over the past five
years. This finding tends to discreditthe view

that California banks are earning excess profits
from exercising market power.
On the other hand, the banking market in California is characterized by a higher degree of
concentration than markets in other major banking states. The percentage of deposits or assets
controlled by the top four or five banks has been
higher in California for the past several years than
in such states as New York, Illinois, and Pennsylvania. Superficially, therefore, Cal ifornia banking
may be less competitive than elsewhere.
These figures, however, may overstate the extent
of concentration (and, hence, potential bank
market power) because they do not account for
the substantial presence of savings and loan associations in the state. The market concentration
measures would decline more in California than
in other market states since S&Ls now hold more
than half of the state's total deposits.

The jury is still out
The evidence on the California rate mystery
clearly is mixed. Indeed, the mystery may have
to remain unsolved until after 1991 when restrictions on entry by out-of-state banks are removed.
If interest rate differentials between California
and other markets disappear when out-of-state
banks move into California, a case could be
made then that competition among banks previously had been low.
On the other hand, these rate differentials may
result from local market conditions. In this case,
banks entering the state after 1991 will adapt to
local conditions, changing their operating style
to reflect the California market, and the rate
differentials will persist.
Our preliminary analysis indicatesthatthe
California rate mystery has two plausible explanations. Banking in California is fairly concentrated and California banks do pay lower rates on
MMDAs and Super NOWs. However, different
costs and perhaps different service levels suggest
that the banking market is different in California.
At a minimum, this discussion reveals that it is
hazardous to draw policy implications from
simple statistical comparisons.

Jonathan A. Neuberger
Economist

Gary C. Zimmerman
Economist

REGIONAL BANKING DATA
September 30, 1988
(Not Seasonally Adjusted, Preliminary Data)

DISTRICT

ASSETS

LOANS

SECURITIES

TOTAL
FOREIGN
DOMESTIC
TOTAL
FOREIGN
DOMESTIC
REAL ESTATE
COMMERCIAL
CONSUMER
AGRICULTURE
INTERNATIONAL
TOTAL
U.S. T.S.
SECONDARY MARKET
OTHER SEC.

LIABILITIES TOTAL
DOMESTIC
DEPOSITS
TOTAL
FOREIGN
DOMESTIC
DEMAND
TIME AND SAVINGS
OTHER BORROWINGS
EQUITY CAPITAL
LOAN LOSS RESERVE
STANDBY LETTERS OF CREDIT
LOAN COMMITTMENTS
LOANS SOLD

LOAN LOSS RESERVE (ALL BANKS)
NET CHARGEOFFS, TOTAL
REAL ESTATE
COMMERCIAL
CONSUMER
AGRICULTURE
PAST DUE & NONACCRUAL, TOTAL
REAL ESTATE
COMMERCIAL
CONSUMER
AGRICULTURE

INCOME

TOTAL
INTEREST
FEES & CHARGES
EXPENSES
TOTAL
INTEREST
SALARIES
LOAN LOSS PROVISION
OTHER
INCOME BEFORE TAXES
TAXES
NET INCOME
ROA (%)
ROE (%)

ALASKA

ARIZONA

CALIF

HAWAII

IDAHO

NEVADA

OREGON

UTAH

WASH

424,279
41,107
383,172
290,233
32,453
257,780
107,556
72,281
53,038
4,981
284
42,669
13,539
15,769
13,361

4,755
1
4,754
2,354
1
2,352
974
899
231
7
N/A
1,262
822
213
227

27,305
N/A
27,305
19,768
N/A
19,768
8,731
4,782
4,166
500
54
3,745
1,576
608
1,560

296,034
39,104
256,930
202,706
31,254
171,452
75,944
48,910
30,372
2,445
223
23,428
6,349
11,318
5,762

13,138
1,063
12,075
7,944
692
7,252
3,649
1,938
1,225
16
0
2,455
917
518
1,021

7,334
N/A
7,334
4,834
N/A
4,834
1,226
1,261
1,345
628
N/A
1,446
536
432
478

12,011
N/A
12,011
8,997
N/A
8,997
1,573
1,432
5,671
21
N/A
1,919
619
400
901

19,303
0
19,303
12,350
5
12,344
3,740
4,804
2,619
373
0
3,348
1,034
707
1,608

11,094
73
11,021
7,225
N/A
7,225
2,881
1,738
1,990
115
2
1,753
418
739
596

33,305
866
32,439
24,056
501
23,556
8,838
6,517
5,420
876
5
3,311
1,268
834
1,209

400,027
358,920
337,817
32,515
305,303
77,992
227,311
38,097
24,252
8,304
31,944
135,854
100,018

4,347
4,347
3,870
1
3,869
979
2,890
429
408
97
26
391
48

25,555
25,555
22,806
N/A
22,806
4,633
18,173
2,362
1,750
390
702
5,492
217

280,351
241,247
236,005
30,834
205,171
56,899
148,271
24,070
15,683
6,683
28,151
109,344
99,038

12,265
11,202
11,440
800
10,640
1,857
8,784
275
873
127
335
3,535
82

6,821
6,821
5,895
N/A
5,895
986
4,909
844
513
90
110
985
13

11,281
11,281
6,171
N/A
6,171
1,821
4,351
4,648
730
226
152
1,209
96

18,029
18,029
15,303
N/A
15,303
3,187
12,116
1,936
1,274
171
520
4,188
327

10,302
10,228
8,635
73
8,562
1,606
6,956
1,208
793
128
289
1,585
19

31,076
30,210
27,692
807
26,885
6,023
20,862
2,326
2,229
393
1,660
9,126
179

2.86
1.17
0.34
0.82
1.66
0.04
5.48
5.44
5.01
2.74
11.70

4.12
7.45
15.10
3.34
0.75
N/A
20.90
35.80
14.20
3.17
4.68

1.97
1.13
0.61
1.02
1.81
0.43
8.23
12.40
8.39
1.86
4.08

3.30
1.15
0.13
0.69
1.78
-.59
5.61
4.35
5.09
2.94
17.70

1.60
0.17
0.01
0.06
0.28
0.42
1.69
1.43
1.78
1.92
33.10

1.85
0.72
0.29
1.42
0.66
0.84
2.36
2.90
2.53
1.87
3.64

2.51
1.91
0.46
1.77
2.39
N/A
4.04
5.35
3.34
3.95
0.57

1.39
0.86
0.39
0.66
1.18
1.02
3.27
5.96
2.17
1.87
5.44

1.77
1.48
0.67
2.42
0.89
0.84
4.47
6.38
3.83
2.05
3.64

1.64
0.98
0.36
1.28
1.21
0.79
4.41
6.08
4.75
2.08
5.73

32,033
26,799
1,510
28,106
13,985
5,802
1,882
6,437
3,905
1,404
2,697
0.86
14.80

304
260
14
369
157
67
62
82
-65
-0
-65
-1.80
-21.00

1,966
1,709
105
1,842
928
389
162
363
124
30
98
0.49
7.49

22,286
18,414
1,040
19,510
9,676
4,109
1,231
4,495
2,761
1,044
1,867
0.86
15.90

972
815
25
791
433
172
31
155
179
63
116
1.20
17.70

536
480
30
475
261
80
30
104
60
18
43
0.78
11.10

1,132
1,007
35
911
421
125
118
247
221
68
153
1.75
27.90

1,368
1,193
74
1,149
596
244
50
259
214
64
152
1.09
15.90

828
735
43
779
394
121
77
187
49
14
35
0.43
5.82

2,640
2,188
145
2,278
1,118
496
120
544
362
104
298
1.21
17.80

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Barbara Bennett) or to the author. ... Free copies of Federal Reserve
publications can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702,
San Francisco 94120. Phone (415) 974-2246.

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DISTRICT

DEPOSIT TYPE

ALASKA

ARIZONA

CALIF

HAWAII

CB SL CU

CB SL CU

CB SL CU

CB SL CU

CB SL CU

NEVADA

IDAHO

CB SL CU

OREGON

UTAH

WASH

CB SL CU

CB SL CU

CB SL CU

CB SL CU

----------------------------------------------------------.--------------------------------------------------------------------TOTAL DEPOSITS
4650
DEMAND
93 5
NOW
6033
SAVINGS & MMDA
5834
SMALL TIME
2672
LARGE TIME
3267
CB
COMMERCIAL BANKS; SL

=

4
2
7
8
3
1

=

72 9 19
5343 4
41 55 3
65 30 5
98 1 1
94 4 2
94 3 3
93 5 2
51 16 34
6428 8
5638 6
72 25 3
54 837
65 27 8
5637 7
61 29 10
69 20 10
40 58 2
1978 2
40 58 2
95 4 1
3762 1
2772 1
79 19 3
SAVINGS & LOANS AND MUTUAL SAVINGS BANKS; CU

TYPE OF ACCOUNT OR LOAN

DATE

US

DISTRICT

ARIZONA

=

CALIF

86 11
99 1
88 7
87 9
82 16
84 11
CREDIT

5439 7
5833 8
6629 5
65 32 3
3
95 4 1
91 7 3
96 2 2
0 100 0 0
64 24 12
69 22 10
7618 6
77 16 7
5
55 30 15
62 19 19
7021 9
6926 5
4
4057 3
4254 4
5047 3
3463 2
2
45 54 1
6433 3
64 33 3
5446 0
5
UNIONS; MAY NOT SUM TO 100% DUE TO ROUNDING

HAWAII

IDAHO

OREGON

UTAH

WASH

-----------------------------------------------------------------------------------------------------------------------MONEY MARKET DEPOSIT ACCOUNTS

6-MONTH CERTIFICATES

2-1/2 YEAR CERTIFICATES

SEP88
OCT88
NOV88
SEP88
OCT88
NOV88
SEP88
OCT88
NOV88

5.63
5.67
5.78
7.37
7.46
7.65
8.16
8.18
8.30

5.33
5.37
5.42
6.74
6.79
6.99
7.81
7.81
7.94

5.21
5.22
5.29
6.47
6.47
6.81
8.09
7.88
7.92

5.39
5.45
5.47
6.68
6.72
6.93
7.68
7.68
7.82

5.28
5.29
5.41
6.39
6.46
6.64
7.89
7.89
8.21

5.21
5.25
5.35
7.45
7.54
7.77
8.28
8.33
8.38

4.92
4.94
4.99
6.90
6.97
7.16
8.19
8.19
8.29

5.80
5.84
5.92
7.41
7.52
7.80
8.02
8.02
8.33

5.08
5.10
5.10
6.53
6.63
6.68
7.59
7.68
7.75

10.30
COMMERCIAL LOANS, SHORT- TERM*
9.41
11.14
NOV88
11.93
10.11
9.88
10.45
9.70
10.29
AVERAGE MATURITY (DAYS)
186
20
113
123
48
65
135
41
87
10.16
11.34
COMMERCIAL LOANS, LONG-TERM*
12.44
NOV88
10.79
11.03
N/A
11.72
11.70
10.95
30
AVERAGE MATURITY (MONTHS)
49
35
47
71
57
43
59
N/A
10.11
CONSTRUCTION LOANS*
N/A
N/A
NOV88
11.04
N/A
10.89
11.68
10.87
N/A
3
AVERAGE MATURITY (MONTHS)
N/A
N/A
7
20
5
20
N/A
N/A
10.96
LOANS TO FARMERS*
10.94
11.95
NOV88
11.59
10.64
10.34
9.50
12.02
10.76
8
AVERAGE MATURITY (MONTHS)
9
5
9
7
6
9
6
45
11.25
10.96
CONSUMER LOANS, AUTOMOBILE
10.50
13.00
NOV88
11.22
11.60
N/A
12.37
N/A
16.00
16.05
CONSUMER LOANS, PERSONAL
13.61
"NOV88
13.00
15.06
15.87
N/A
18.11
N/A
15.75
19.24
18.55
CONSUMER LOANS, CREDIT CARDS
NOV88
17.77
19.32
N/A
N/A
18.26
N/A
SOURCES:
SURVEY OF TERM OF BANK LENDING & TERMS OF CONSUMER CREDIT; MOST COMMON INTEREST RATES ON SELECTED ACCOUNTS
* U.S. DATA ARE COMPOUNDED ANNUAL RATES, DISTRICT AND STATE DATA ARE SIMPLE ANNUAL RATES.