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April 29, 1983

On the Offensive
The banking and thrift industries have taken
the offensive with the introduction of the
Money Market Deposit Account (M M DA)
and its companion account, the 5uperN OW. These new accounts enable banks
and thrifts to compete more effectively with
money market mutual funds (MMFs).
Indeed, the Gam-51. Germain Act, passed in
October 1982, had required the Depository
Institutions Deregulation Committee (DI D O
to authorize an instrument that was directly
competitive with MMFs. Congress intended
to promote competition between the depository institutions and the MMFs by providing
for a ceiling-free deposit account with
liquidity and limited transactions capabilities.
The public has found the M M D A to be an
extremely attractive instrument since it
offers the important combination of market
rates, liquidity, low minimum balances and
deposit insurance. Moreover, depository
institutions are taking an aggressive marketing stance by offering high interest rates on
the M M D A to make it their chief instrument
in head-to-head competition with the MMFs.
Banks and thrifts could afford to offer higher
rates to make the M M D A more attractive
than the Super-N OW because the former is
a limited transactions account and personal
M M D As are not subject to reserve requirements. In contrast, Super-N OW balances
are treated as transactions balances subject
to a 12-percent reserve requirement In
addition, the cost of servicing the limited
transactions of M M D As is less than the cost
of providing unlimited checking services for
the Super-N OW.
Armed with these new accounts, depository
institutions have responded aggressively by
developing new products and services in an
effort to recapture some of the $232 billion
held by taxable MMFs in mid-December,
and to capture a larger portion of new funds

flowing into the market Some MMFs will
continue to offer features currently not
available from depository institutions, such
as accounts tied to securities transactions
and brokerage services, speCific investments
(i.e., eurodollarsl which offer a higher return
with more risk, or tax-exempt funds. These
segments of the market will continue to
remain fairly insulated from direct competition with depository institutions. The bu Ik of
M M F balances, however, will be subject to
competitive pressure from the MM DAs.
Promotional blitz
To introduce M M D As and, to a lesserextent,
Super-N OWs, depository institutions conducted a tremendous promotional blitz.
Full-page advertisements and TV spots highlighted those features of the M M D As not
shared by the MMFs, including FDIC/FSLlC
deposit insurance of up to $100,000 per
depositor, the convenience of holding the
account at a "full service" institution,
and access to funds via automated teller
machines. As if these features were not
enough to attract depositors, a wide variety
of attractive bonuses ranging from cash to
travel offers were thrown in as sweeteners.

In addition, banks and thrifts took full advantage of the ceiling-free interest rate feature of
M M D As and Super-N OWs by offering
premium rates well above the market yield
paid by MMFs to attract the public's attention and to overcome depositor inertia.
While many institutions offered "introductory" rates in the 1 0- to 12-percent range
for M M D As, a few paid annual rates of 20
percent or more. Institutions competed
against each other with these premium rates
in an attempt to capture a larger share of the
market As expected, the introductory
premiums have deClined recently, and
M M D A rates have moved into closer alignment with short-term market rates, settling
slightly above M M F yields.

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Opinions
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Reserve Svstern.
institutions are developing more sophisticated fee schedules. Some institutions have
raised service charges and fees to offset the
costs of providing checking services with
these accounts. Others pay different interest
rates depending on the size of balances, or
scale service charges according to the balance held in the account in orderto segment
deposits by fee and rate sensitivity.

Balance sheets restructured
As of early April, the M M D A had drawn
more than $333 billion, perhaps $70 billion
of which came from outside the banking
system (perhaps $40 billion from MM Fs and
the rest from instruments such as Treasury
bills). In fact, the M M D A has had the most
rapid growth of any ofthe consumer deposit
instruments ever authorized. Its growth has
been even more dramatic than that experienced by the MMFs during 1 980 and 1 981 .
In contrast, the lower rates paid on SuperN O Ws and the decision by many banks to
"soft-pedal" the account have resuIted in its
much slower growth. At the end of March,
Super-N OWs had grown to about $28 billion, and attracted only a small percentage
of new deposits.

Banks and thrifts also face several potentially costly risks associated with their
increasing reliance on these short-term
variable-rate liabilities. First, the popularity
of the new accounts has reduced the effective maturity and thus increased the sensitivity of the cost of bank liabilities to inteyest
rate movements. This development could
weigh heavily on the sensitivity of an institution's profits to changes in short-term
interest rates, unless other assetadjustments
are made. Second, the liquid nature of these
deposits increases the possibility of "rate
wars" breaking out among competing institutions. Thus, those institutions relying on
the M M D A and Super-N OW as potential
core deposits are linking a wide variety of
banking services to the accounts to prevent
their loss to institutions offering higher yields.

Although the taxable MMFs have lost over
$50 billion since these accounts were introduced, depository institutions have been
drawing money primarily from their existing
deposit bases-consumers and businesses
with small-denomination time deposits and
passbook savings accounts. Furthermore,
commercial banks reported sizable reductions in large time deposits outstanding as
some large certificates of deposit (CDs over
$100,000) were converted into M M D As and
as the inflow of funds into the M M D As
allowed institutions to reduce their need to
issue large CDs.

The future?
What are the prospects for the MMFs and the
depository institutions offering the M M D As
and Super-N OWs? First, it is unlikely that
the M M F industry will disappear. Existing
regulations allow them to collect funds
nationwide, to provide unique services
(especially in brokerage-related products),
to tailor their risk-return mix and tax status to
specific investors' preferences, and to allow
unlimited numbers of checks without the
imposition of reserve requirements. By differentiating their product, perhaps some
M MFs can limit competition with depository
institutions. Those MMFs that try to compete
will likely offer improved payments services
and/or private insurance as important seiling points. Moreover, MMFs will have
incentives to reduce operating costs and fees
to boost the net yields offered.

••• But at what cost?
The popularity of the M M D A has not been
without cost. Earnings at depository institutions wi II be affected adversely by the conversion of lower cost liabilities into M M D As
and Super-N OWs. ( While the majority of
the internal funds converted into M M D As
was already paying market rates, most of the
money flowing into Super-N OWs has come
from low-yielding checking and N O W
accounts.) In addition, earnings will suffer
temporarily because of the introductory
marketing costs and premiums paid to
attract funds into the new accounts.
To minimize the negative impactof M M D As
and Super-N O Ws on earnings, depository
2

MMDA DEPOSITS AND MMF SHARES

RATES ON MMDAs AND MMFs

Percent

$ Billions

10.5

350
MMDAs

300

10.0
9.5

250

9.0

200

as

MMFs

150

MMDAs

ao

100
50
0'" 2!'2":i
'!:',
2
Dec
1982

5 12 19 26 2
Jan

__

_

_ ; :
MMFs

7.5

'!'!"'!"-:'!'"*'

o 22

9 16 23 2 9 16 23 30 6
Feb
Mar
Apr
1983

2" 5 12 "

Dec
1982

Jan

26 ..
2

.. .. ..
9 16 23 2 9 16 23 30 6
Feb
Mar
Apr
1983
M

..

-

the rate depository institutions would otherwise be willing to pay by 20 to 30 basis
points. The MMFs receive a lower return on
these assets,and, because they currently
hold nearly 18 percent of their assetsin CDs,
the reduced return forces them to pay a
lower yield to their shareholders. (Of course,
not all MMFs will be affected to the same
extent because their portfolios vary widely.)

For depository institutions, the prospects are
bright. M M D As have opened an important
market in which deposit insurance and
differential reserve requirements on
various categories of deposits will give them
important advantages over the money
market funds.
Deposit insurance on the new accounts is
the key feature for small institutions with
limited access to the national money
markets. In the pre-M M D A world, these
institutions had difficulty obtaining funds at
the "best" bank rates because of their small
size and restricted local markets. When they
were able to tap the national markets for
uninsured purchased funds (large CDs,
primarily), they typically paid a significant
risk premium to do so.

Over time, a number of other factors will
also come into play in determining the ability of banks' and thrifts' to offer competitive
rates on M M D As. General movements in
short-term interest rates, which determine
M M F yields with a lag, and their ability to
manage their portfolios, as well as their
ability to offer attractive services at a cost
that is competitive with MM Fs' costs, cou Id
very well determine the extent to which
depository institutions are able to lure funds
away from MMFs.

The M M D A has generated net inflows at
most institutions sufficient to reduce their
need for purchased funds. In addition, since
the fees these banks and thrifts pay for
deposit insurance are typically lower than
the risk premia they would have had to pay
to obtain funds in the national markets, the
M M D A has significantly lowered the marginal cost of funds for smaller institutions.
For many, the cost of obtaining funds
through the M M D A is so much lower than
that of obtaining funds on the open market
that they should be able to offer higher yields
than the MMFs and still find that their
marginal cost for M M D As is below their
marginal cost for open market borrowings.

In the long-run, these qualifications could
offset the advantages arising from deposit
insurance and differential reserves. Nevertheless, depository institutions are currently
making the most of their ability todetermine
their own rates on M M D As and of the other
advantages they have to outbid the MMFs in
the battle for liquid, market-return core
deposits.

Conclusion
Depository institutions will continue to
press the advantages they have gained with
the new instruments. To date, both large and
small banks have been able to outbid the
MMFs, and thus, to attract billions. The
M M D A has indeed proven to be "directly
competitive" with a money fund account.
Depository institutions should continue to
dominate the market and turn a profit now
that they can offer these accounts and price
them according to their demand for funds,
investment opportunities, interest margins,
and desired market share.

Institutions (typically larger banks) that
already had access to the national markets·
for purchased funds at the "best" bank rate
have found that reserve requirement differentials, rather than deposit insurance,
provide them with a major competitive
advantage over the MMFs. M M D A deposits
in personal accounts do not carry a reserve
requirement, while large CDs purchased
from depository institutions by MMFs and
other non-personal investors have a threepercent reserve requirement. At present, the
higher reserve requirement on CDs lowers

Gary C. Zimmerman and Jennifer l. Eccles

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BANKING DATA-TWELFTHFEDERAL
RESERVE
DISTRICT
(Dollar amounts in millions)

Selected Assets'and liabilities
large Commercial Banks
Loans (gross, adjusted) and investments'"
Loans (gross, adjusted) -total#
Commercial and industrial
Real estate
Loans to individuals
Securities loans
U.S. Treasury securities"
Other securities"
Demand deposits - total#
Demand deposits - adjusted
Savings deposits - totalt
Time deposits - total#
Individuals, part. & corp.
(Large negotiable CD's)

Weekly Averages
of Daily Figures
Member Bank Reserve Position
Excess Reserves (+ )/Deficiency (-)
Borrowings
Net free reserves (+ )/Net borrowed( -)

Amount
Outstanding

Change
from

4/13/83
163,867
142,726
44,763
57,057
23,518
3,195
8,220
12,920
41,914
29,218
66,429
67,157
59,964
20,633

4/6/83
193
97
- 407
41
62
1,202
41
56
-1,093
- 334
- 155
366
356
174

Change from
year ago
Dollar
Percent

5,096
5,235
1,950
30
248
1,172
1,878
- 2,017
926
800
34,641
- 23,508
- 21,256
- 12,554

Weekended

Weekended

4/13/83

4/6/83

89

o

89

111
14
97

-

-

3.2
3.8
4.6
0.1
1.1
57.9
29.6
13.5
2.3
2.8
109.0
25.9
26.2
37.8

Comparable
year-ago period

81
31
50

" Excludes trading account securities.
# Includes items not shown separately.
t Includes Money Market Deposit Accounts,
accounts, and N O W accounts.
Editorial comments may be addressedto the editor (Gregory Tong)or to the author ... . . Freecopies of
this and other Federal Reservepublications can be obtained by calling or writing the Public
Information Section, Federal ReserveBank of San Francisco, P.O. Box 7702, San Francisco 94120.

Phone (415) 974-2246.

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