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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. 1 l02 IP 11" ifi\ll 11« 1 J Y'\1 if (G) §@\ 111 1t' iX\'1 1\ (("C\.j) (,-\\ (CV, Opinions in thi" do not ne·cessarilv n,'jleci the vivvvs (II the rn<:H1dgPIll{'nt of the nank ol San r:rancisco, or ol!he Goarcl of Coverno(s of 1(1(' Federal 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 3 LlOl8U! YSE'M YPln • u08;;:.uO PPPAClN 0YPPI 0 • • !!E'(v\E'H• P!UJoJ!I-e) • E'UOZ! • p>jselV JV C\lJ 1)ill \\ill!1) l '@(jJ \ J 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. \l{];j) l '@ J (Ql