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FRBSF WEEKLY LETTER July 27, 1990 Interest Rate Competition Since late 1982, commercial banks and thrifts have offered the money market deposit account (MMDA), a savings account with features similar to and competitive with those of money market mutual funds. Until 1987, banks and thrifts offered rates on MMDAs that were closely tied to the rates on money market funds. Since then, however, MMDA rates have become less sensitive to money fund rates. In this Letter, we study this change in MMDA pricing, and find that changes in the structure of banking markets caused by changes in the intensity of thrift competition may be partly responsible. The MMDA market is born Money market deposit accounts were authorized for banks and thrifts in December 1982 as a combination savingsliimited transaction account that would make them competitive with money market mutual funds. Today, banks and thrifts in the U.S. hold nearly $490 billion in MMDAs, versus about $430 billion in money funds. in the money fund rate in a rising rate environment is confirmed by research at the Federal Reserve Bank of San Francisco. When interest rates have risen, banks and thrifts have been able to limit the rise in their MMDA rates without too much risk of losing deposits. Instead, they have tended to raise interest rates on certificates of deposit (CDs). Changes in CD rates affect only new accounts, and are therefore less costly than are changes in the MMDA rate, which would apply to both new and old accounts. Interest Rates on Money Market Funds and MMDAs .i /\\ , Mon,ey Market Fund / i, At the same time, MMDA rates tended to be less sensitive to rises than to declines in the rate on money market funds. This tendency for the MMDA rate to respond less strongly to changes WESTERn BAnKinG f:: .r'\ ! '. 9 ....... "..._.... /' ..J Money market funds pay a rate that is determined by the yields on the money market assets (such as Treasury securities, commercial paper, and large bank CDs) they hold. In contrast, depository institutions establish their own rates on MMDAs. Through the mid-1980s, the rates on money market funds and MMDAs were tightly linked, with MMDA rates only slightly below those on money funds (see chart). Data from the Bank Rate Monitor indicate that bank and thrift MMDA rates averaged 94 percent of the national average money market fund rate from 1984 to 1986. Moreover, changes in these two rates were highly correlated, with MMDA rates moving an average of 60 basis points for every 100 basis point change in money fund rates. Percent !'.,\ ./ ..../ 7 MMDA ,.. ,.~.!~---~---~-----,-- . Large California S&L MMDA 1984 1985 1986 1987 Source: Bank Rate Monitor 1988 1989 8 1990 6 5 4 Looser link According to the chart, the close relationship between money market fund and MMDA rates appears to have broken down after 1986. The average differential between rates paid on money market funds and MMDAs has widened significantly. Whereas MMDA rates in the 1984-86 period were five to ten percent below the money fund rate, after 1986 they have been more than 20 percent below the money fund rate on average. The average difference between MMDA rates and the money market fund rate climbed from under 100 basis points from 1984 to 1986 to over 200 basis points after 1986. 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 In the current period, changes in MMDA rates also respond less to changes in money fund rates. For every 100 basis point change in the average money market fund rate since early 1987, MMDA rates have moved on average on Iy 20 basis points. This is one-third of the response of MMDA rates in the prior period. Interest sensitivity of MMDAs The apparent uncoupling of MMDA and money market fund rates may have occurred for a number of reasons. First, it may be a response to the rise in the money fund rate that occurred during most of the later period. As noted above, MMDA rates have tended to be less responsive to money fund rates when rates have been rising than when they have been falling. Thus, it should not be a surprise that money fund and MMDA rates would appear to have become uncoupled as interest rates rose after 1986. However, a rising money fund rate cannot fully explain the apparent uncoupling of rates in the current period. The spread between the two rates is too large to be consistent with the earlier period. Moreover, as money fund rates have fallen over the past year, MMDA rates have not been as responsive to this decline as they were previously. Money fund rates have fallen about 160 basis points since early 1989, but MMDA rates have fallen only 40 basis points or so; this is roughly the same average response that we observe during the post-1986 period as a whole. The thrift crisis Thus, a structural shift in the market for MMDAs appears to have occurred around 1987. This shift has altered the relationship between rates on MMDAs and those on money funds. It is difficult to identify a unique cause for this. Nevertheless, the uncoupling of MMDA rates from money fund rates coincides with the deterioration in the financial condition of FSLlC-insured thrift institutions. Such a deterioration in financial condition may have limited thrift competition in the MMDA market, and diminished banks' incentives to compete aggressively as well. As early as the second half of 1985, the S&L industry began reporting net outflows of new retail savings deposits. Earnings deteriorated dramatically thereafter, with the industry as a whole reporting virtually zero earnings in 1986 and progressively larger multi-billion dollar losses in subsequent years. The industry's return on assets (ROA) followed a similar pattern of deterioration. Another sign of the deteriorating health of the industry has been the declining number of insured thrifts. A small drop in 1986 was followed by much larger declines in subsequent years. With the funding to close insolvent thrifts that was provided by the passage of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) in August 1989, the number of thrift institutions has declined even further. As the financial prospects and performance of thrifts have deteriorated, the industry has attempted to minimize its cost of funds, bolster earnings, and raise capital. As a result of these efforts, the ability of thrifts to compete in the MMDA market may have declined. FIRREA also has limited the ability of ailing thrifts to offer above-market deposit rates. Consequently, the premium thrifts have been paying over bank MMDA rates has declined in recent years. The behavior of MMDA rates at a group of large California S&Ls is especially striking. As shown in the chart, these S&Ls have paid an almost constant rate on MMDAs since 1986, despite strong movements in money fund rates. In contrast, MMDA rates at large California banks are now higher than rates at large California S&Ls for the first time in years. Impact on depositors Competition for depositors' funds can take many forms. In California, for example, banks have escalated efforts to provide "better" banking services, such as 24-hour telephone service, longer branch hours, and Saturday banking. Nevertheless, developments in the thrift industry appear to have diminished competition in the market for MMDAs and contributed to an uncoupling of MMDA and money market fund rates. Thus, it is not surprising that MMDA balances have fallen $24 billion nationwide since 1987 while higher yielding money market funds have gained $116 billion. Gary C. Zimmerman Economist Jonathan A. Neuberger Economist REGIONAL BANK DATA MARCH 31, 1990 (Not SeasonaLLy Adjusted, PreLiminary Data) DISTRICT ALASKA -------- ARIZ. CALIF. HAWAII IDAHO NEVADA OREGON UTAH WASH. -------- -------- -------- -------- ASSETS TOTAL FOREIGN DOMESTIC 468,779 40,570 428,209 4,238 1 4,237 27,138 N/A 27,138 325,149 38,204 .286,945 16,313 1,912 14,401 8,078 N/A 8,078 15,958 N/A 15,958 22,334 N/A 22,334 11,383 81 11,301 38,188 371 37,817 LOANS TOTAL FOREIGN DOMESTIC REAL ESTATE COMMERCIAL CONSUMER AGRICULTURE INTERNATIONAL 336,042 32,671 303,370 140,596 76,538 58,479 4,904 380 1,846 0 1,846 714 659 282 6 N/A 17,995 N/A 17,995 6,940 3,883 5,210 464 14 238,820 31,582 207,239 105,767 51,921 31,213 2,458 365 9,257 965 8,292 3,895 2,484 1,294 38 0 5,256 N/A 5,256 1,444 1,382 1,492 506 N/A 12,114 N/A 12,114 2,221 1,622 7,919 17 N/A 15,066 N/A 15,066 4,784 5,325 3,224 321 N/A 7,237 N/A 7,237 2,939 1,713 1,926 122 N/A 28,450 125 28,325 11,890 7,549 5,918 974 0 SECURITIES TOTAL U. S. T. S. SECONDARY MARKET OTHER SEC. 42,824 12,848 17,875 12,101 1,741 1,116 213 412 3,265 1,133 1,029 1,103 21,193 5,933 9,893 5,367 3,391 996 1,533 863 1,726 478 728 520 1,969 633 573 763 3,783 950 1,558 1,276 2,092 464 1,096 532 3,664 1,145 1,252 1,266 438,899 398,329 372,641 34,964 337,677 3,789 3,788 3,334 0 3,334 25,413 25,413 23,187 N/A 23,187 304,891 266,687 259,498 32,748 226,751 15,377 13,465 14,466 1,764 12,702 7,542 7,542 6,489 N/A 6,489 14,920 14,920 8,182 N/A 8,182 20,791 20,791 17,376 N/A 17,376 10,614 10,533 8,954 81 8,873 35,561 35,190 31,154 371 30,784 79,285 32,628 258,392 64,601 31,537 71,046 58,048 910 226 2,424 419 357 707 697 4,463 2,174 18,724 4,841 1,221 8,039 2,431 57,035 20,900 169,716 44,041 22,408 39,258 42,760 2,337 1,235 10,365 2,095 1,375 1,749 3,906 1,053 768 5,435 1,063 375 2,586 617 1,981 842 6,202 1,666 872 1,197 1,625 3,296 2,239 14,080 2,942 1,415 5,567 1,908 1,649 1,057 7,224 1,512 795 2,905 955 6,561 3,188 24,223 6,022 2,719 9,037 3,150 43,774 29,880 8,060 178,886 65,000 403 449 42 557 22 1,720 1,725 702 8,464 423 26,977 20,258 6,116 135,288 63,861 426 936 143 5,561 110 967 535 89 1,771 22 5,811 1,038 214 2,187 2,784 1,543 211 7,467 98 215 1,473 768 143 2,651 17 3,212 2,627 400 14,942 233 LOAN LOSS RESERVE (ALL BANKS) NET CHARGEOFFS, TOTAL REAL ESTATE COMMERCIAL CONSUMER AGRICULTURE 2.40 0.72 0.16 0.39 1.97 -.97 2.29 0.15 0.33 0.07 0.28 N/A 3.90 1.64 0.46 3.65 2.32 -.07 2.56 0.63 0.10 0.26 1.85 -2.20 1.54 -.02 -.02 -.22 0.29 -.07 1.70 0.23 0.09 0.23 0.62 -.34 1.76 2.88 0.32 1.61 3.88 -.03 1.40 0.51 0.35 0.33 1.17 0.95 1.98 0.83 0.37 1.41 1.29 -.00 1.40 0.44 0.48 -.10 1.03 0.91 PAST DUE & NON-ACCRUAL, TOTAL REAL ESTATE COMMERCIAL CONSUMER AGRICULTURE 4.88 4.50 5.44 3.03 8.77 6.35 8.86 6.94 1.91 2.21 9.82 16.00 11.7 1.65 11.2 4.91 3.73 5.86 2.78 10.8 1.97 2.24 1.84 2.50 4.25 2.01 2.84 1.80 1.36 4.25 6.03 5.89 3.63 6.74 0.95 2.01 2.70 1.59 1.73 3.46 4.15 6.26 3.51 2.53 5.67 4.11 5.46 3.73 1.74 6.15 LIABILITIES TOTAL DOMESTIC TOTAL FOREIGN DOMESTIC DEPOSITS DEMAND NOW TIME AND SAVINGS MMDA SAVINGS SMALL TIME LARGE TIME OTHER BORROW INGS EQUITY CAPITAL LOAN LOSS RESERVE LOAN COMMITTMENTS LOANS SOLD INCOME TOTAL INTEREST FEES & CHARGES 13,412 11,077 578 108 94 5 716 589 39 9,320 7,627 398 397 352 9 213 189 11 663 565 14 590 510 33 302 266 16 1,104 884 54 EXPENSES TOTAL INTEREST SALARIES LOAN LOSS PROVISION OTHER 11,336 6,109 2,139 682 2,405 90 49 21 2 18 731 342 149 74 166 7,805 4,236 1,507 421 1,641 330 206 63 7 54 181 110 29 3 40 551 257 48 102 144 488 280 96 23 90 267 152 42 15 58 892 478 184 35 195 INCOME BEFORE TAXES TAXES NET INCOME 2,071 675 1,544 18 4 14 -16 -7 -9 1,510 521 1,131 67 23 44 32 9 23 112 39 73 101 31 71 35 10 25 212 44 173 ROA (%) ROE (%) NET INTEREST MARGIN 1.34 20.70 4.31 1.32 12.60 4.19 -.13 -2.00 3.74 1.41 22.30 4.24 1.13 18.70 3.76 1.16 17.20 4.01 1.72 28.20 7.25 0.88 12.80 4.09 1.84 26.30 4.33 (%) 1.30 18.30 . 4.26 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 tile 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. palsanba» uo!paJJo) ssaJpPV OUI:'6 v::> 'o:JspUl!Jj Ul!S LOLL x09 'O'd O)SI)UOJ~ JO UOS ~uo8 aAJaSa\:j IOJapa~ ~uaw~Jodaa lpJOasati DEPOSITORY INSTITUTIONS REQUIRED TO HOLD RESERVES WITH THE FEDERAL RESERVE ON A WEEKlY BASIS PERCENT OF COHBINED HARKET TOTAL FOR HAY 1990, BY REGION DISTRICT DEPOSIT TYPE CB SL CU TOTAL DEPOSITS DEMAND NOW SAVINGS HHDA SHALL TIME LARGE TIHE 48 47 92 61 48 65 29 41 ALASKA ARIZONA CALIF HAWAII IDAHO NEVADA UTAH OREGON WASH C6 SL CU CB SL CU CB SL CU CB SL CU CB SL CU CB SL CU CB SL CU CB SL CU CB SL CU 5 4 73 56 34 69 76 95 44 52 4 92 4 4 5737 6 48 3B 14 61 37 2 22 75 3 37 61 2 66 29 5 93 4 4 71 26 3 47 35 18 82 18 0 40 56 4 7918 2 B7 10 3 92 1 6 BB 8 3 76 12 12 94 6 0 83 15 2 84 11 5 6929 99 1 78 16 7020 81 18 43 54 7030 68 26 31 7 34 1B 32 2 68 3 57 2 5639 5 91 4 5 70 22 9 45 26 29 68 21 11 92 4 5 75 14 11 53 12 35 B1 910 5636 B 7816 6 5736 B 93 5 3 65 23 12 45 21 35 70 2B 2 44 51 5 47 52 1 4 422 99 0 1 5 36 3 63 6 3 6 16 2 3 n 22 1 43 54 45 52 3 2 3 0 6 10 2 2 0 95 n 6 1 4 16 7 5427 19 B1 16 4 53 43 5 80 16 4 C8 = COMMERCIAL BANKS; SL = SAVINGS & LOANS AND SAVINGS BANKS; CU = CREDIT UNIONS; MAY NOT SUM TO 100% DUE TO ROUNDING TYPE OF ACCOUNT OR LOAN DATE US DISTRICT ARIZ CALIF HAWAII IDAHO OREGON UTAH WASH 6.38 6.44 6.53 6.45 6.10 6.10 6.34 6.29 6.36 7.n 7.77 7.53 7.61 7.65 7.66 7.15 7.08 7.16 -------------------------------------------------------------------------------------------------------------------------------HONEY HARKET DEPOSIT ACCOUNTS HAR90 APR90 HAY90 6.32 6.33 6.34 6.26 6.21 6.23 5.86 5.87 5.87 6.49 6.46 6.46 5.69 5.68 5.68 6.07 6.06 6.06 92 TO 182 DAYS CERTIFICATES HAR90 APR90 HAY90 7.77 7.B1 7.B3 7.45 7.45 7.48 7.41 7.40 7.3B 7.76 7.B1 7.B2 6.89 6.89 6.95 7.45 7.50 7.57 HAR90 APR90 HAY90 7.94 8.01 8.03 7.86 7.87 7.89 7.64 7.64 7.59 7.9B B.04 7.99 7.57 7.57 8.00 7.9B 8.00 8.00 8.56 8.34 7.98 7.98 8.05 8.05 7.72 7.72 7.71 9.97 11.08 44 11.79 14 10.49 125 11.20 36 10.58 11 10.19 69 10.89 39 10.50 5 10.61 156 11.16 35 10.28 12 10.85 100 11.87 32 NfA NfA 10.05 119 11.47 56 11.67 16 10.58 85 NfA NfA 10.68 3 11.11 115 11.93 26 12.35 47 10.14 158 10.04 40 11.15 24 11.82 15.41 18.14 12.55 13.25 16.22 18.47 17.00 18.00 13.08 19.79 19.44 NfA NfA NfA 13.50 14.00 KfA 11.30 13.27 19.24 11.84 16.14 20.40 12.05 15.07 16.00 21; YEARS AND OVER CERTIFICATES COMMERCIAL, SHORT-TERtt* COMMERCIAL, LONG-TERK* LOANS TO FARI1ERS* CONSUMER, AUTOMOBIL.E CONSUMER, PERSONAL CONSUMER, CREDIT CARDS AVE. AVE. AVE. AVE. AVE. AVE. RATE HAT. (DAYS) RATE HAT. (HONTHS) RATE HAT. (HONTHS) AVE. RATE AVE. RATE AVE. RATE 46 SOURCES: SURVEY OF TERMS OF BANK LENDING AND TERMS OF CONSU"ER CREDIT; "OST COMMON INTEREST RATES ON SELECTED ACCOUNTS. *u.S. DATA ARE COI1POUNDED ANNUAL RATES, DISTRlCT AND STATE DATA ARE SIMPLE ANNUAL RATES.
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