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ECONOMIC REVIEW
Additional copies of the ECONOMIC REVIEW may
be obtained from the Research Department, Federal
Reserve Bank of Cleveland, P. O. Box 6387,
Cleveland, Ohio 44101. Permission is granted to
reproduce any material in this publication providing
credit is given.
AVERAGE FUNCTIONAL
COST AND REVENUE
FOR BANKS IN THREE
SIZE CATEGORIES,
1966-1969
Since the mid-1960's, most Federal Reserve Banks have
offered a Functional Cost Analysis (FCA) program w ithout
charge
to
member
banks.1 FCA
is a uniform
cost
accounting system designed to be a bank management tool
and implemented jo in tly by the sponsoring Federal Reserve
Bank and the participating commercial banks. The commer
cial banks supply certain income, expense, balance sheet,
and activity data to the Federal Reserve Banks; in return,
they receive an analysis of their own income and costs,
broken down by function or activity, along w ith compar
ative data fo r a group of similar banks. In the FCA
program,
IN THIS ISSUE
as in other Federal
Reserve data collection
activities, individual bank data are considered confidential;
thus, group averages and other techniques are used to avoid
Average Functional Cost and
disclosure.
Revenue fo r Banks in
1
Three Size Categories,
$10 billion. The program was made available in all twelve Federal
1966-1969 ................ 3
Participation is limited to member banks with assets of less than
Reserve districts, beginning in 1970. In the Fourth District, this
program is administered by the Bank Relations and Public Informa
tion Department, Federal Reserve Bank of Cleveland.
ECONOMIC REVIEW
As an aid to bank management, the Federal
banks, investments, and loans (instalment, real
Reserve publishes cost and revenue figures fo r the
estate, and commercial and agricultural) constitute
participating banks in three different size cate
the uses of funds. The classification of activities
gories as well as similar data fo r a select group of
into funds-supplying and funds-using categories
high performance banks. Although the primary
permits the calculation of an average cost of
purpose of the FCA program is to provide partici
money rate3 and an average portfolio yield. These
pating commercial banks w ith a uniform cost
calculations, in turn, assist the participating bank
accounting system fo r major banking functions
in the evaluation of the net pro fitab ility of each
and
improving their
banking function. The earnings of a funds-using
performance
of
function are determined by subtracting the cost of
different size banks is of more general interest.
money and the operating cost from the gross
thereby
operational
Accordingly,
assist
them
efficiency,
this
article
in
the
together and
income o f the particular function. Similarly, the
summarizes the average FCA data published by the
draws
earnings of a funds-supplying function are equal to
Federal Reserve fo r the three size categories. The
the difference between the average portfolio yield
data were derived from the individual reports of all
and the expenses of the funds-supplying function.
participants for 1966-1969— period in which the
a
Thus each funds-using function is charged the
data form at was basically unchanged. Emphasis is
same cost of money rate, and each funds-supplying
placed on the differences in the functional cost
function is credited w ith the same gross yield.
and revenue experience of different size banks and
In addition to the analysis of individual fundssupplying and funds-using functions, FCA also
changes in those differences over time.
generates statements of overall earnings, personnel
THE FUNCTIONAL COST ANALYSIS
PROGRAM AND DATA
productivity and cost, and a breakdown o f costs
and income fo r three auxiliary bank service depart
Inasmuch as the correct interpretation of FCA
ments that are considered to be neither funds-
data requires some understanding of the concepts
using nor funds-supplying: computer services, trust
and general approach employed by FCA, it is
departments, and safe deposit operations.
necessary to begin w ith a brief introduction to the
The Nature of the Data. The FCA national
program. A note of caution concerning the lim ita
average reports distinguish three bank size cate
tions of the data is also appropriate.
gories: total deposits up to $50 m illion (Class 1),
The Framework of FCA. The Functional Cost
Analysis
commercial
total deposits of $50-$200 m illion (Class 2), and
a
total deposits over $200 m illion (Class 3). Each
bank in terms of funds-supplying
annual FCA report fo r the years 1966 through
program
views
the
operation
of
Demand
1969 contains average information (such as an
deposits, time deposits, non-deposit liabilities and
average balance sheet, a statement of source and
capital2 are sources of funds; cash and due from
distribution of income, and a cost-revenue analysis
functions
2
and
funds-using functions.
In the FCA approach, all nondeposit funds are included
3The cost of money is the sum of operating and interest
in capital accounts. Net capital, a frequently used FCA
costs of all funds-supplying functions less any service
concept,
charge or other fee income. In the FCA program, it is
refers to total
nondeposit funds less bank
premises and other fixed assets.
4
used
principally
as a percent
of
available funds.
APRIL 1971
of the various bank functions) fo r these three size
(largest size) bank. The superior record of the
classes. The published figures are computed by
Class 2 bank, when compared w ith
aggregating the reports of the.individual banks in a
resulted from a lower cost per dollar of available
Class 1,
particular class and then dividing by the number of
funds, a factor that outweighed the lower gross
banks in the class, even though all banks in the
portfolio yield of the Class 2 bank. The perfor
program do not maintain all functions. During
mance of the Class 3 bank was found to have been
1966-1969, the average number of banks in each
adversely affected by a generally lower income per
class was: Class 1, 710; Class 2, 227; and Class 3,
dollar of available funds that was not sufficiently
80. The FCA figures, therefore, obviously refer to
offset by lower costs.
a fictional bank; the balance sheet, functional
The data also indicate that the relative p ro fit
earnings, and expenses correspond to the average
ability of various bank functions differed fo r the
reported fo r the class. An analyst should not,
three
therefore, impute the characteristics o f the average
1966-1969, the highest net earning loan function
bank
classes.
Over
the
entire
period
bank to individual members o f the class. In order
(per dollar of invested funds) at the Class 1 bank
to keep this point consistently before the reader,
was instalment lending; whereas commercial and
the average FCA figures w ill be discussed as
agricultural lending tended to be among the least
relating only to the Class 1 bank, the Class 2 bank,
profitable. Commercial and agricultural lending,
and the Class 3 bank.
however, was the highest net earning loan function
Generalizations about the entire banking system
(per dollar of invested funds) at the Class 3 bank
from the experience of the average FCA banks
in 1969. The data also indicate that the unit of
should also be tempered by the understanding that
output is important in determining which bank
participation in the Functional Cost program is
class had the lowest average cost fo r any function.
voluntary. The participants do not constitute a
For example, in 1966-1968, the Class 3 bank had
random sample of all commercial banks.
the lowest cost of demand deposits in terms of the
It should also be noted that, for a given year,
cost per dollar of such deposits, but the highest
there are only three observations from which to
cost
infer relationships between cost or revenue and
processing a deposit or clearing a check.
per
unit
of
account
activity,
such
as
size. Finally, the foreword to the FCA National
Average Report warns: "Bank cost accounting is
not
an
exact
science."
For
example,
some
subjective judgment is required in the allocation of
BANK SIZE CLASS AND EARNINGS,
INCOME, AND EXPENSE
For 1966-1969, the Class 2 bank consistently
cost to various functions.
achieved the highest earnings (gross income less
SOME GENERAL FINDINGS
expenses before taxes) per $1,000 of available
Given their limitations, the FCA data patterns
are still o f interest. The data show that, during
funds. The Class 1 bank was second; and the Class
3 bank, third (see Table I).
1966-1969, earnings per dollar of available funds
Total (gross) income and total expenses are also
(the sum of loans and investments plus cash and
shown in Table I to provide an indication of the
due from banks) were highest fo r the Class 2
relative contribution of each to earnings. These
(intermediate size) bank and lowest fo r the Class 3
data indicate that the higher earnings performance
ECONOMIC REVIEW
TABLE I
Income, Expenses, and Earnings per $1,000 of Available Funds
Averaged fo r Banks in Three Size Categories
1966-1969
Banks With
Deposits up to
$50 Million
Banks With
Deposits $50
Million to
$200 Million
Banks With
Deposits Over
$200 Million
(Class 1)
(Class 2)
(Class 3)
$56.25
$54.99
$52.82
39.21
17.04
37.03
17.96
36.26
16.56
58.76
56.73
55.11
41.48
17.28
38.92
17.81
38.17
16.94
62.65
61.25
61.10
43.65
19.00
40.95
20.30
42.27
18.83
68.46
67.45
68.22
46.60
21.86
44.52
22.93
47.47
20.75
1966
Total available
funds income
Total available
funds expenses
Earnings
1967
Total available
funds income
Total available
funds expenses
Earnings
1968
Total available
funds income
Total available
funds expenses
Earnings
1969
Total available
funds income
Total available
funds expenses
Earnings
NOTE: Total available funds income includes earnings from loans, investments,
and service charges. Tax-exempt income has been converted to a taxable
basis in all FCA data. Expenses include the processing and administrative
cost of loans and investments and the "cost of money." Earnings are
before Federal taxes and exclusive of gains or losses from security
transactions.
Source: Functional Cost Analysis National Average Reports
of the Class 2 bank, when compared w ith the Class
tially lower expenses per dollar of available funds
1 bank, was not due to a higher income rate. (In
that more than offset the lower total income per
fact, total income per dollar of available funds
dollar of funds. Expenses per dollar of available
declined as the bank size category increased, w ith
funds were even lower fo r the Class 3 bank in
the partial exception of 1969.) Rather, this higher
1966 and 1967 than fo r the Class 2 bank, but this
ranking of the Class 2 bank was due to substan
advantage was inadequate to compensate fo r lower
6
APRIL 1971
income per dollar of available funds. Rapidly rising
In order to translate comparative balance sheets
costs at the Class 3 bank in 1968 and 1969
into an explanation of why gross income per dollar
partially offset the relative gains in income per
of available funds declined as bank size increased,
dollar of available funds, so that this bank group
it is necessary to know the yields on the various
continued to lag behind the net earnings perfor
asset categories.
mance o f the smaller bank groups.
Gross Yields on Portfolio Assets. Table III
In order to see why revenues and costs behaved
contains average gross and net yield data fo r the
as they did fo r the three bank groups, it is
portfolio assets held by the three bank groups for
necessary to examine their asset and liability
the period 1966 through 1969. By a wide margin,
characteristics.
instalment loans had the highest average gross
yield of any item in the bank portfolios. The gross
ASSET CHARACTERISTICS
yields on commercial and agricultural loans, real
The balance sheets of the three categories of
estate mortgages, and investments followed in
FCA banks fo r the period 1966-1969 show some
descending order for all bank classes—
except in
rather persistent differences (see Table II). The
1969,
dollar volume o f cash and balances due from banks
exceeded the gross return on real estate loans.
when
the
gross
yield
on
investments
(as a percent o f total assets) consistently increased
It is important to note that gross yields on all
w ith bank size, while holdings of U. S. Govern
asset categories did not consistently decline as
ment securities declined. In each year, the Class 2
bank size increased (see Table III). The decline in
bank allocated a larger share of its portfolio to
gross income per dollar of available funds asso
tax-exempt obligations than the other two groups.
ciated w ith increasing bank size can be explained
Real estate and instalment loans made up a smaller
in terms of a portfolio composition effect. There
proportion of total assets at larger banks than at
are heavier concentrations of high-income instal
the Class 1 banks, and commercial and agricultural
ment loans in the higher yield portfolios and of
loans increased in importance with average bank
cash and commercial and agricultural loans in the
size. Overall, the Class 3 and Class 2 banks held
lower yield portfolios.
higher proportions of cash and balances due and
Operating Cost and Net Yields on Portfolio
specialized more in commercial loans4 than the
Assets. In addition to gross rates of return on
Class 1 bank. The Class 2 and Class 1 banks
various assets, Table III also shows the effect of
allocated a larger proportion of funds to instal
operating costs in making and servicing various
ment and real estate loans and U. S. Government
loans and investments. These costs constitute a
securities than the Class 3 bank.
portion of the total available funds expense shown
in Table I; the cost of money is not included in
4 ln
1969, agricultural
loans constituted
less than
2
Table III. Since the FCA approach charges each
percent of the volume of total commercial and agricul
lending function the same cost of money rate, the
tural loans at FCA banks with deposits over $200 million.
omission of this cost does not affect the relative
For
net yield on different assets. In addition, cost of
the
Class
amounted
commercial
to
1 bank,
over
and
10
however, agricultural
percent
agricultural
of
loans.
the
F unctional
Analysis N ational Average Reports, 1969, p. A17.
loans
volume
of
Cost
money is more appropriately discussed in connec
tion w ith its source: liab ility structure and cost.
7
ECONOMIC REVIEW
TABLE II
Percentage Distribution of Assets
Averaged fo r Banks in Three Size Categories
1966-1969
Banks With
Deposits up to
$50 Million
Banks With
Deposits $50
Million to
$200 Million
Banks With
Deposits Over
$200 Million
(Class 1)
(Class 2)
(Class 3)
1966
Cash and due from banks
U. S. securities
Tax-exempt obligations
Real estate mortgage loans
Instalment loans
Commercial and agricultural loans
Other
12.03%
19.49
12.06
17.50
12.35
19.99
6.58
13.19%
15.74
13.22
15.18
12.07
24.35
6.25
16.63%
10.56
11.02
13.83
8.62
32.96
6.38
11.73
18.06
12.70
17.38
12.49
7.52
13.17
15.26
14.03
15.52
11.40
23.51
7.11
16.17
11.38
12.15
13.83
8.51
30.91
7.05
11.27
17.28
13.43
17.89
12.33
19.82
7.98
12.97
14.76
15.01
16.18
11.61
22.34
7.13
15.44
11.15
13.30
15.12
9.21
28.88
6.90
11.35
14.77
14.07
18.37
12.94
20.18
8.32
12.76
15.46
8.82
13.02
15.57
9.70
30.60
6.83
1967
Cash and due from banks
U. S. securities
Tax-exempt obligations
Real estate mortgage loans
Instalment loans
Commercial and agricultural loans
Other
20.12
1968
Cash and due from banks
U. S. securities
Tax-exempt obligations
Real estate mortgage loans
Instalment loans
Commercial and agricultural loans
Other
1969
Cash and due from banks
U. S. securities
Tax-exempt obligations
Real estate mortgage loans
Instalment loans
Commercial and agricultural loans
Other
NOTE: Other includes such items as other bonds and stocks, Federal funds sold,
commercial paper, brokers' loans, bankers' acceptances, and bank
premises and real estate.
Source: F unctional Cost Analysis N ational Average Reports
8
12.68
15.57
17.02
12.16
22.84
6.97
APRIL 1971
TA B L E III
Gross Yields, Operating Costs and Net Yields on P ortfolio Assets
Averaged for Banks in Three Size Categories
(percent per annum)
1966-1969
Banks With
Deposits up to
$50 Million
Banks With
Deposits $50
Million to
$200 Million
(Class 1)
(Class 2)
(Class ;
4.79%
0.15
4.64
4.93%
0.12
4.81
5.26%
0.13
5.13
5.80
0.80
5.00
5.77
0.69
5.08
5.88
0.63
5.25
9.49
3.08
6.41
9.16
3.15
6.01
8.84
3.27
5.57
6.03
1.29
4.74
5.91
0.99
4.92
5.91
0.68
5.23
5.03
0.13
4.90
5.14
0.10
5.04
5.40
0.12
5.28
5.96
0.79
5.17
5.95
0.69
5.26
6.12
0.71
5.41
9.81
3.20
6.61
9.51
3.39
6.12
9.51
3.66
5.85
6.33
1.30
5.03
6.17
1.03
5.14
6.19
0.72
5.47
5.78
0.13
5.65
5.99
0.11
5.88
6.23
0.12
6.11
6.12
0.73
5.39
6.13
0.62
5.51
6.3 6
0.62
5.74
9.99
3.15
6.84
9.72
3.33
6.39
10.03
3.92
6.11
6.63
1.26
5.37
6.62
1.03
5.59
6.75
0.80
5.95
6.67
0.15
6.52
6.75
0.12
6.63
7.05
0.16
6.89
6.37
0.71
5.66
6.32
0.63
5.69
6.64
0.67
5.97
10.21
3.35
6.86
9.99
3.64
6.35
10.49
4.08
6.41
7.39
1.31
6.08
7.66
1.08
6.58
7.95
0.84
7.11
Banks W ith
Deposits Over
$200 Million
1966
Investments
Gross yield
Operating cost
Net yield
Real estate mortgage loans
Gross yield
Operating cost
Net yield
Instalment loans
Gross yield
Operating cost
Net yield
Commercial and agricultural loans
Gross yields
Operating cost
Net yield
1967
Investments
Gross yield
Operating cost
Net yield
Real estate mortgages
Gross yield
Operating cost
Net yield
Instalment loans
Gross yield
Operating cost
Net yield
Commercial and agricultural loans
Gross yield
Operating cost
Net yield
1968
Investments
Gross yield
Operating cost
Net yield
Real estate mortgage loans
Gross yield
Operating cost
Net yield
Instalment loans
Gross yield
Operating cost
Net yield
Commercial and agricultural loans
Gross yield
Operating cost
Net yield
1969
Investments
Gross yield
Operating cost
Net yield
Real estate mortgage loans
Gross yield
Operating cost
Net yield
Instalment loans
Gross yield
Operating cost
Net yield
Commercial and agricultural loans
Gross yield
Operating cost
Net yield
N O TE: Operating cost does not include the cost of money and thus is not
equivalent to total functional expense.
Source: F u n ctio n a l Cost A nalysis N ational Average Reports
9
ECONOMIC REVIEW
TABLE IV
Ranking of Asset Categories Based on Average Net Yields
Earned by Banks in Three Size Categories
1966-1969
1966
1967
1968
1969
Banks With Deposits up to $50 Million (Class 1)
I
II
III
IV
instalment loans
real estate loans
commercial and
agricultural loans
investments
instalment loans
real estate loans
commercial and
agricultural loans
investments
instalment loans
investments
real estate loans
commercial and
agricultural loans
instalment loans
investments
commercial and
agricultural loans
real estate loans
Banks With Deposits of $50 to $200 Million (Class 2)
I instalment loans
real estate loans
II
III commercial and
agricultural loans
IV investments
instalment loans
real estate loans
instalment loans
investments
commercial and
agricultural loans
investments
commercial and
agricultural loans
real estate loans
investments
commercial and
agricultural loans
instalment loans
real estate loans
Banks With Deposits Over $200 Million (Class 3)
I instalment loans
II
real estate loans
III commercial and
agricultural loans
IV investments
instalment loans
instalment loans*
commercial and
agricultural loans
real estate loans
investments*
investments
commercial and
agricultural loans
real estate loans
commercial and
agricultural loans
investments
instalment loans
real estate loans
* In 1968, instalment loans and investments had the same average net yield for
C(ass 3 banks.
Source: F unctional Cost Analysis National Average Reports
It is interesting to note that assets w ith the
banks.5 The Class 1 bank, however, reported the
highest gross rates of return generally tended to
lowest cost per dollar of instalment loans. Simi
have the highest operating costs. As a result, the
larly, the average operating costs for real estate
range of average yields, net of operating costs, was
loans and investments were less fo r the Class 2
much smaller than the range of average gross
bank than fo r the Class 1 bank. The cost of real
yields. The operating costs associated w ith various
estate loans was about the same fo r the Class 3
5
lending activities were obviously not the same for
each bank class. For example, the average per
dollar cost of making and servicing commercial
It should be remembered that if the average cost of some
process is found to vary with firm size, this does not
necessarily mean that the high cost firms are poorly
managed. It may mean only that different size firms are
and agricultural loans was much lower for the
necessarily faced with differences in, for example, the
Class 3 bank than fo r the Class 1 or Class 2
cost of inputs or the technique of production.
10
APRIL 1971
bank as fo r the Class 2 bank, but the cost of
investments was slightly higher for Class 3 than for
Class 2.
L IA B IL IT Y CHARACTERISTICS
AND THE COST OF MONEY
During
1966-1969,
persistent differences in
liability structure by bank size category existed, as
A fter subtracting costs of operation, instalment
was the case w ith the asset side of the balance
loans still had the highest average yield for all bank
sheet (see Table V). Specifically, the liabilities of
categories during 1966-1968. This is shown in
the Class 2 bank included a higher proportion of
Table III and is emphasized in Table IV, which
regular savings accounts and a slightly larger
ranks asset categories on the basis of average net
percentage of demand deposits than either the
yields earned by each bank class. In 1969, instal
Class 1 or Class 3 banks. Until 1969, the liabilities
ment loans continued to have the highest net yield
of the Class 2 bank also contained the smallest
for the Class 1 bank, but investments rose to first
proportion of certificates of deposit (CDs) and
place for the Class 2 bank. The highest net yield
"other time deposits.”
earned by the Class 3 bank in that year was on
percent of total liabilities, were about the same at
commercial and agricultural loans.
the Class 2 and Class 3 banks, but borrowings
In that year, CDs, as a
(including Federal funds purchased) at the Class 3
To summarize, net earnings per dollar of avail
able funds were highest fo r the Class 2 bank and
bank were over three times as high as the
proportion of borrowings at the Class 2 bank.
lowest fo r the Class 3 bank during 1966-1969.
This behavior of net earnings reflects differences in
As shown by Table V I, demand deposits had the
gross income and bank costs at the three banks.
lowest
Gross income per dollar of available funds tended
Following demand deposits, in ascending order of
average
cost
of
all
bank
liabilities.
to vary inversely w ith bank size, while total bank
cost, were regular savings accounts, certificates of
costs declined more than bank income from the
deposits and other time deposits, and borrowings
smallest to the intermediate size bank. From the
(except that in 1967, borrowings were unusually
intermediate to the largest bank, total expenses
low in price). Thus, the unique liability structure
per dollar of available funds either declined less
of the Class 2 bank means that this bank was in
than revenue or actually increased. The decrease in
the advantageous position of paying less for funds
reported gross income associated with increasing
than other banks—not because it was always able
bank size appears to be due to differences in
to issue any given liab ility fo r less, but because its
portfolio composition.
liabilities were more heavily concentrated in low
average cost categories.
Asset and yield data, however, are inadequate to
explain
why
total
average
expense
initially
An interesting question is why this bank had
such
a relatively
desirable liab ility
structure.
Unfortunately, the FCA data do not provide a
declined so sharply and hence why earnings per
dollar of available funds were at a peak fo r the
well-defined answer, but rather are consistent w ith
Class 2 bank. For this explanation, it is necessary
a number of possibilities. Whatever the cause,
to broaden the discussion tP include the cost of
however, the consequence of the Class 2 liability
money, which involves liability structure and cost.
structure for the cost of money is unequivocal. As
11
ECONOMIC REVIEW
TABLE V
Distribution of Selected Liabilities
Averaged fo r Banks in Three Size Categories
(percent of total liabilities and capital)
1966-1969
Banks With
Deposits up to
$50 Million
Banks With
Deposits $50
Million to
$200 Million
Banks With
Deposits Over
$200 Million
(Class 1)
(Class 2)
(Class 3)
45.63%
28.60
47.39%
29.61
46.87%
24.73
15.36
11.72
14.46
1.09
1.83
4.45
43.95
26.77
45.69
28.09
45.47
23.27
19.17
15.40
18.51
1.03
1.65
3.32
42.00
25.63
43.89
26.72
43.47
23.47
22.41
18.57
20.33
1.14
1.82
3.90
41.12
23.56
42.65
25.32
41.83
21.57
24.97
20.60
20.30
1.42
2.37
7.66
1966
Demand deposits
Regular savings accounts
Certificates of deposit and
other time deposits
Borrowings and other
liabilities
1967
Demand deposits
Regular savings accounts
Certificates of deposit and
other time deposits
Borrowings and other
liabilities
1968
Demand deposits
Regular savings accounts
Certificates of deposit and
other time deposits
Borrowings and other
liabilities
1969
Demand deposits
Regular savings accounts
Certificates of deposit and
other time deposits
Borrowings and other
liabilities
Source: Functional Cost Analysis National Average Reports
Table V II shows, the Class 2 bank had the lowest
While the overall cost of money was the lowest
cost of money in each year.
at the Class 2 bank in 1966-1969, the behavior of
®The cost of money figures shown in Table V II are
the components of operating cost—processing and
affected not only by liability structure but also by the
administrative costs—
in the demand and time
cost and volume of capital funds at each bank. The capital
deposit functions was sufficiently complex and
funds function, in this paper, is treated only in part; i.e.,
the "borrowings” portion. A complete discussion was
omitted in the interest of brevity and because of the
difficulty of obtaining comparable cost figures on liabil
revealing to warrant detailed examination.
The Demand Deposit Function. In 1966-1967,
ities and equity capital. For example, the FCA program
demand deposit cost per dollar of demand deposits
does not include dividend payments in the cost of equity.
was lowest at the Class 3 bank and highest at the
12
APRIL 1971
TABLE VI
Total Operating and Interest Cost (Less A ctivity Charges) for Selected Liabilities
Averaged fo r Banks in Three Size Categories
(percent per annum)
Banks With
1966-1969
Banks With
Deposits up to
$50 Million
Deposits $50
Million to
$200 Million
Banks With
Deposits Over
$200 Million
(Class 1)
(Class 2)
(Class 3)
1.47%
3.98
1.33%
4.16
1.25%
4.42
4.14
4.32
4.75
5.10
5.10
5.10
1.57
4.13
1.42
4.24
1.39
4.47
4.45
4.62
4.83
4.37
4.23
4.44
1.74
4.22
1.56
4.34
1.53
4.52
4.79
4.93
5.17
5.49
5.57
6.82
1.76
4.49
1.61
4.59
1.73
4.64
5.06
5.14
5.50
7.62
7.77
9.55
1966
Demand deposits
Regular savings accounts
Certificates of deposit and
other time deposits
Borrowings and other
liabilities*
1967
Demand deposits
Regular savings accounts
Certificates of deposit and
other time deposits
Borrowings and other
liabilities
1968
Demand deposits
Regular savings accounts
Certificates of deposit and
other time deposits
Borrowings and other
liabilities
1969
Demand deposits
Regular savings accounts
Certificates of deposit and
other time deposits
Borrowings and other
liabilities
NOTE: Average cost of borrowings and other liabilities do not include operating
expenses.
* Cost of borrowings for 1966 are not strictly comparable with figures for later
years.
Source: F unctional Cost Analysis N ational Average Reports
Class 1 bank (Table V III). The Class 3 bank,
Another interesting aspect of the data in Table
however, experienced more rapidly rising costs
V III
than the other bank groups; and this advantage
substantial economies of scale in the use of tellers,
eroded to the point that, in 1969, the Class 2 bank
but diseconomies in the use of other support
had the lowest cost per dollar of demand deposits.
personnel in the demand deposit function at the
is an indication
of what appear to be
13
ECONOMIC REVIEW
TABLE VII
Cost of Money*
Averaged for Banks in Three Size Categories
(percent per annum)
1966-1969
1966
Deposits up to $50 million (Class 1)
Deposits $ 5 0 —$200 million (Class 2)
Deposits over $200 million (Class 3)
1967
1968
1969
2.67%
2.58
2.69
2.88%
2.76
2.84
3.14%
3.00
3.15
3.37%
3.26
3.58
* The cost of money is computed by summingthe operating and interest costs of
all funds-supplying functions less any service charge or other fee income and
dividing by the quantity of available funds.
Source: F unctional Cost Analysis N ational Average Reports
Class 3 bank. The larger the bank, the lower the
debits ("on us" checks) and accounts per non
expense was for teller salaries per dollar of demand
teller employee in the demand deposit function
deposits; but wages, other than for tellers, per
decreased.
dollar of demand deposits were lowest for the
support
Class 2 bank
economies
rather than the Class 3 bank.
Nevertheless,
activities
were
elsewhere.
any
diseconomies
insufficient
As
has
to
already
in
offset
been
Moreover, since 1966, the Class 1 bank had
observed, when measured in terms of cost per
incurred significantly lower expenses than the
dollar of demand deposits, the Class 3 and Class 2
Class 3 bank for these "backroom '' wages per
banks had lower overall demand deposit costs than
dollar
the Class 1 bank.
of
demand
deposits. Other processing
expense (which includes furniture and equipment,
Cost per dollar of demand deposits, however, is
computer, stationery and supply charges) was
not the only measure of cost performance. For
consistently lowest per dollar of deposits fo r the
example, a different picture emerges from an
Class 3 bank. The Class 2 and Class 3 banks—but
examination of the cost of a unit of deposit
never the Class 1 bank—had at various times during
activity in checking accounts, such as cashing a
the four-year period the lowest administrative and
check or accepting a deposit. As Table X shows,
overhead cost per dollar of deposits. As a result,
the per unit cost of every demand deposit activity,
the Class 2 and Class 3 banks had lower total
as well as the annual maintenance charge per
demand deposits costs per dollar of deposits than
account, increased directly w ith bank size. More
the Class 1 bank.
One measure of the productivity of tellers and
other demand deposit employees at the three
over, the cost difference between bank classes—
and the cost advantage of the Class 1 b a n k increased from 1966 through 1969.
banks is shown in Table IX. A teller at the Class 3
Class 2 and Class 3 banks were able to achieve
bank handled more deposits per day than his
lower costs per dollar of checking account volume
counterpart at the Class 2 or Class 1 bank and
(Table V III) —in spite of higher costs per unit of
cashed as many checks. On the other hand, as the
deposit activity as shown in Table X. This appears
bank size increased, the number of daily home
to be due principally to the fact that deposit
14
APRIL 1971
TABLE V III
Demand Deposit Expense
Averaged fo r Banks in Three Size Categories
(dollars per $1,000 o f demand deposits)
1966-1969
Banks With
Deposits up to
$50 Million
Banks With
Deposits $50
Million to
$200 Million
Banks With
Deposits Over
$200 Million
(Class 1)
(Class 2)
(Class 3)
1966
Teller salaries
Transit and bookkeeping wages
Total processing wages
Other processing expense
Administration and overhead
Total expense
& 3.44
4.19
$ 2.36
5.05
9.74
7.63
6.86
6.86
$ 4.66
5.08
6.45
5.58
7.41
5.28
5.71
23.05
20.07
18.40
4.47
5.58
3.21
4.66
2.31
6.03
10.05
7.50
6.91
7.87
7.25
6.07
8.34
5.98
5.71
24.46
21.19
20.03
4.69
5.36
3.41
4.81
2.69
6.06
10.05
8.14
7.87
8.22
7.49
6.73
8.75
6.90
6.75
26.06
22.44
22.40
4.96
5.48
3.68
4.92
2.85
6.98
10.44
8.75
7.42
8.60
8.05
6.88
9.83
7.71
7.18
26.61
23.53
24.72
1967
Teller salaries
Transit and bookkeeping wages
Total processing wages
Other processing expense
Administration and overhead
Total expense
1968
Teller salaries
Transit and bookkeeping wages
Total processing wages
Other processing expense
Administration and overhead
Total expense
1969
Teller salaries
Transit and bookkeeping wages
Total processing wages
Other processing expense
Administration and overhead
Total expense
Source: F unctional Cost Analysis N ational Average Reports
activity did not rise in proportion to the dollar
Class 1 bank)7 contributed to this lower per dollar
volume o f deposits. The average size of checking
cost; maintenance expense was spread over a larger
accounts at the Class 3 bank ($3,918 in regular
7 Functional
checking accounts in 1969 versus $1,960 for the
1969, p. A8.
Cost Analysis N ational Average Report,
15
ECONOMIC REVIEW
TABLE IX
Output of Employees in the Demand Deposit Function
Averaged fo r Banks in Three Size Categories
1966-1969
Banks With
Deposits up to
$50 Million
Banks With
Deposits $50
Million to
$200 Million
Banks With
Deposits Over
$200 Million
(Class 1)
(Class 2)
(Class 3)
71
84
317
420
71
73
298
335
87
83
246
238
76
96
322
423
79
84
286
325
233
232
75
78
358
459
78
76
303
340
91
80
245
256
75
77
381
480
79
79
325
365
89
80
234
245
1966
Daily deposits per teller
Daily checks cashed per teller
Daily home debits per trans-bookkeeper*
Accounts per trans-bookkeeper
1967
Daily deposits per teller
Daily checks cashed per teller
Daily home debits per trans-bookkeeper
Accounts per trans-bookkeeper
86
t
1968
Daily deposits per teller
Daily checks cashed per teller
Daily home debits per trans-bookkeeper
Accounts per trans-bookkeeper
1969
Daily deposits per teller
Daily checks cashed per teller
Daily home debits per trans-bookkeeper
Accounts per trans-bookkeeper
* Trans-bookkeeper is an abbreviation for all demand deposit employees other
than tellers.
t Unavailable. The published figure is incorrect.
Source: F unctional Cost Analysis N ational Average Reports
dollar volume.
Account activity
(measured in
from the FCA studies indicate that larger size does
terms of weighted home debits, deposits, and
not necessarily imply lower cost. Whether or not
transit checks) per dollar of checking accounts also
average cost rises or falls from one bank size
declined as deposit volume rose. These effects are
category to another depends on the measure of
summarized in Table XI in terms of the number of
output.
activity weight units (including annual mainte
nance) per dollar of checking account funds for
The Time Deposit Function. Differences in the
the three bank groups. The sharp decrease in
operation of the time deposit function by bank
activity per dollar of checking account funds as
size were similar to those differences observed in
bank size increased is quite apparent.
the operation of the demand deposit function. The
The data regarding the demand deposit function
16
Class 3 bank had the lowest cost in terms of
APRIL 1971
TABLE X
Costs o f Demand Deposit A ctivity and Maintenance
Averaged for Banks in Three Size Categories
(cents per item)
1966-1969
Banks With
Deposits up to
$50 Million
Banks With
Deposits $50
Million to
$200 Million
Banks With
Deposits Over
$200 Million
(Class!)
(Class 2)
(Class 3)
1966
Home debit
Deposit
Transit check*
Regular checking account—annual
maintenancet
Special checking account—
annual
maintenance
6.27 C
8.77
2.30
6.64C
9.29
2.43
1,657.73
1,755.54
1,807.00
552.52
1,023.95
1,053.97
6.89
9.65
2.53
7.34
10.26
2.69
7.92
11.09
2.90
1,823.45
1,939.91
2,095.41
607.75
1,131.49
1,396.78
7.32
10.25
2.68
8.00
11.20
2.93
8.46
11.84
3.10
1,936.98
2,117.04
2,238.39
645.59
1,411.20
1,492.10
7.47
10.46
2.74
8.24
11.53
3.02
9.88
13.83
3.62
1,976.42
2,179.83
2,614.25
658.74
1,089.79
1,742.64
6.83C
9.56
2.50
1967
Home debit
Deposit
Transit check
Regular checking account—
annual
maintenance
Special checking account—annual
maintenance
1968
Home debit
Deposit
Transit check
Regular checking account—
annual
maintenance
Special checking account—
annual
maintenance
1969
Home debit
Deposit
Transit check
Regular checking account—
annual
maintenance
Special checking account—
annual
maintenance
NOTE: Home debits include all "on us” checks plus all charges against checking
accounts.
* Transit checks is a term covering all outgoing clearing items,
t Annual maintenance cost is the average cost to the bank of servicing a deposit,
even if the deposit is inactive.
Source: F unctional Cost Analysis National Average Reports
17
ECONOMIC REVIEW
TABLE XI
Weighted A ctivity Units* Per $1.00 of Checking Account Funds
Averaged fo r Banks in Three Size Categories
1966-1969
1966
Deposits up to $50 million (Class 1)
Deposits $ 50—$200 million (Class 2)
Deposits over $200 million (Class 3)
1967
1968
1969
.935
.746
.634
.919
.732
.627
.920
.721
.657
.926
.739
.634
* One weight unit equals the activity (cost) required to process one transit check.
Since every activity involves a cost, the cost of any given activity may be
expressed as a multiple of the cost of any other activity. FCA uses the cost of a
transit check as the standard unit.
Source: F unctional Cost Analysis N ational Average Reports
TABLE X II
Operating Cost of Time Deposits
Averaged fo r Banks in Three Size Categories
(cost in dollars per $1,000 o f time deposits)
1966-1969
Banks With
Deposits up to
$50 Million
Banks With
Deposits $50
Million to
$200 Million
Banks With
Deposits Over
$200 Million
(Class 1)
(Class 2)
(Class 3)
$2.23
2.23
$2.33
2.23
$2.08
1.99
4.46
4.56
4.07
2.26
2.27
2.37
2.17
2.30
1.73
4.53
4.54
4.03
2.29
2.10
2.46
2.08
2.27
1.89
4.39
4.54
4.16
2.58
2.54
2.77
2.60
2.64
2.15
5.12
5.37
4.79
1966
Processing expense
Administration and overhead expense
Total operating expense
1967
Processing expense
Administration and overhead expense
Total operating expense
1968
Processing expense
Administration and overhead expense
Total operating expense
1969
Processing expense
Administration and overhead expense
Total operating expense
Source: F unctional Cost Analysis N ational Average Reports
18
APRIL 1971
TABLE X III
Cost of Time Deposit A ctivity
Averaged fo r Banks in Three Size Categories
(cents per transaction)
1966-1969
Banks With
Deposits up to
$50 Million
Banks With
Deposits $50
Million to
$200 Million
Banks With
Deposits Over
$200 Million
(Class 1:
(Class 2)
(Class 3)
5 6 .10 0
61.71
173.91
56.69 <
?
62.36
175.74
72.67 C
79.94
225.28
63.07
69.37
195.51
60.53
66.59
187.65
74.42
81.86
230.70
66.79
73.47
207.06
64.59
71.05
200.22
72.66
79.93
225.25
76.71
84.38
237.79
78.82
86.70
244.34
85.01
93.51
263.54
1966
Deposit
Withdrawal
Account opened
1967
Deposit
Withdrawal
Account opened
1968
Deposit
Withdrawal
Account opened
1969
Deposit
Withdrawal
Account opened
Source: F unctional Cost Analysis N ational Average Reports
operating expense per dollar of time deposits
(Table
X II).
Costs per unit of time deposit
activity, however, tell a different story. As Table
BANK SIZE AND PERSONNEL
EXPENDITURE
The
FCA study also compiles and reports
XI11 shows, the Class 1 and Class 2 banks had the
average data on the number of and expenditure for
lowest average cost per transaction unit over the
total personnel for the three bank classes. Much of
four-year period. The Class 3 bank consistently
this information is summarized in Table X IV . The
had the highest per unit cost fo r time deposit
top panel in the Table indicates that the Class 3
activity, just as it had the highest per unit activity
bank was able to operate w ith fewer employees
cost in the demand deposit function. Again, the
per dollar of available funds. This situation is often
Class 3 bank was able to achieve low adminis
attributed to increased specialization of labor at
trative and processing costs per dollar of time
larger banks, which results in higher overall output
deposits chiefly because deposit activity did not
per employee. As noted in the previous two
increase in proportion to deposit volume.
sections, however, it may also be attributed to the
19
ECONOMIC REVIEW
TABLE X IV
Personnel Use and Cost
Averaged fo r Banks in Three Size Categories
1966-1969
1967
1966
1968
1969
Number of employees per $1,000,000 of available funds
2.10
2.02
1.86
Deposits up to $50 million (Class 1)
Deposits $ 50—$200 million (Class 2)
Deposits over $200 million (Class 3)
1.79
1.59
1.53
1.86
1.67
1.58
1.83
1.69
1.57
$ 5.92
5.97
6.35
6.27
6.81
Annual personnel expense per employee ($1,000 of dollars)
Deposits up to $50 million (Class 1)
Deposits $ 5 0 —$200 million (Class 2)
Deposits over $200 million (Class 3)
$ 5.28
5.35
5.72
$ 5.58
5.64
6.02
6.22
Annual personnel expense in dollars per $1,000 of available funds
Deposits up to $50 million (Class 1)
Deposits $ 5 0 —$200 million (Class 2)
Deposits over $200 million (Class 3)
$ 11.01
$11.27
10.10
9.57
$11.09
9.95
8.75
$11.38
10.60
10.69
9.97
10.03
Personnel expense as a percent of gross income on available funds
Deposits up to $50 million (Class 1)
Deposits $ 50—$200 million (Class 2)
Deposits over $200 million
21.03%
19.48
17.76
20.49%
19.19
18.65
19.23%
18.06
18.01
18.28%
17.46
17.16
Source: F unctional Cost Analysis N ational Average Reports
fact that there was less to be done (account
bank widened during this period of generally
activity was less) per dollar of available funds at
increasing personnel cost.
the Class 3 bank; therefore, fewer personnel were
The net effect of the changing relative produc
required to process a dollar of funds. During
tiv ity and remuneration at the various banks on
1966-1969, the Class 1 and Class 2 banks had
personnel expense per dollar of available funds is
considerable success in reducing the number of
shown in the third panel of Table X IV . Because of
employees
In
productivity gains at the Class 1 and Class 2 banks
contrast, the ratio of employees to available funds
and larger increases in wages and salaries at the
at the Class 3 bank was practically unchanged
Class 3 bank, the Class 2 bank replaced the Class 3
per
dollar
of
available funds.
from 1967 through 1969.
The second panel in Table XIV reveals that the
Class 3 bank
had higher personnel cost per
bank w ith the lowest personnel expense per dollar
of available funds. As the bottom panel shows,
however,
personnel
expenditure
remained
a
employee than the Class 2 and Class 3 banks. It is
smaller percentage of gross income for the Class 3
also apparent that expense per employee at the
bank than fo r the other two bank groups.
Class 3 bank increased more over the 1966-1969
period than personnel expense in the other bank
A U X IL IA R Y SERVICE FUNCTIONS
groups. The gap between personnel expense per
Three specific service functions are analyzed in
employee at the Class 3 bank and at the Class 1
the functional cost study—
computer services, trust
20
APRIL 1971
TABLE XV
Losses in Auxiliary Bank Service Departments
Averaged fo r Banks in Three Size Categories
(percent of departmental expense)
1966-1969
1966
1967
1968
1969
15.97%
11.51
8.89
13.29%
13.97
10.11
12.51%
13.27
6.11
20.28
9.55
(9.46)
24.18
11.78
(1.59)
27.37
12.24
(1.66)
29.89
17.91
1.92
35.84
37.21
34.35
27.58
32.34
25.44
26.41
30.00
32.70
38.66
39.57
37.57
Computer service department
Deposits up to $50 million (Class 1)
Deposits $50—$200 million (Class 2)
Deposits over $200 million (Class 3)
9.67%
9.87
6.61
Trust department
Deposits up to $50 million (Class 1)
Deposits $50—$200 million (Class 2)
Deposits over $200 million (Class 3)
Safe deposit department
Deposits up to $50 million (Class 1)
Deposits $ 50—$200 million (Class 2)
Deposits over $200 million (Class 3)
NOTE: Profits are in brackets; losses are unbracketed.
Source: F unctional Cost Analysis N ational Average Reports
operations, and safe deposit. Table XV shows that,
SUMMARY
except for the trust department operations of the
This survey of the published FCA bank data for
Class 3 bank, these departments were operated at a
the years 1966-1969 has indicated pronounced
loss throughout the period. The fact that these
differences in the functional revenue and cost
services appear to be provided at a loss does not
flows of the different size banks. Using earnings
necessarily mean that FCA banks would be well
per dollar o f available funds as the criterion, the
advised
service
Class 2 bank consistently achieved the highest
departments are maintained because they generate
to
eliminate
them.
Auxiliary
overall performance, and the Class 3 bank just as
funds and profitable business in other bank depart
consistently ranked third. The overall superiority
ments. Strictly speaking, all of these losses should,
of the Class 2 bank over the Class 1 bank was due
therefore, be allocated as expense items to those
to substantially lower cost per dollar of available
departments that benefit from the presence of
funds. This more than compensated for the lower
auxiliary service functions in the bank.
O
Such an
gross yield received by the Class 2 bank. The
allocation, however, is not feasible.
relatively inferior performance of the Class 3 bank
0
was
Expenses for computer services performed for specific
due
to
an
unfortunate combination
of
bank functions are allocated to those functions; the
generally lower income and insufficient offsetting
remaining auxiliary service expenses are not allocated.
cost economies.
21
ECONOMIC REVIEW
Differences in asset structure and yield by bank
(except for demand deposits in 1969); but in
size categories were also noted. Specifically, larger
terms of cost per unit of deposit activity, the Class
banks were found to hold higher proportions of
3 bank had the highest cost record. These results
cash and commercial and agricultural loans, while
can be reconciled by the fact that as deposit
the smaller banks' portfolios on average contained
volume grows, deposit activity increases less than
heavier concentrations o f instalment and real
in proportion to deposit volume.
estate loans and U. S. Government securities.
During the period under review,. because of
productivity gains at the Class 1 and Class 2 banks
The liability structure and cost was also seen to
and more rapidly rising labor cost at the Class 3
vary considerably w ith bank size. The Class 2
bank, the Class 2 bank replaced the Class 3 bank in
bank, in particular, was the beneficiary of a
having the lowest personnel expense per dollar of
liability composition that was weighted towards
available funds.
low average cost items. Substantial differences
Generally, a conclusion that may be drawn from
were also found in the cost of producing and
the FCA data is that, during 1966-1969, bank size
maintaining demand and time deposit liabilities.
did make a difference in functional costs and
Viewed in terms of operating cost per dollar of
revenues, and this difference did not always favor
deposits, the Class 3 bank achieved the lowest cost
the largest banks.
22
The
1970 Functional Cost Analysis National Average
Report w ill be available in June 1971 from the Bank
Relations and Public Information
Reserve Bank of Cleveland.
Department, Federal
APRIL 1971
RECENTLY PUBLISHED ECONOMIC COMMENTARIES
OF THE FEDERAL RESERVE BANK OF CLEVELAND
"A Note on the Bank Holding Company Act Amendments of 1970"
March 22, 1971
"Some Aspects of the Auto Recovery"
March 29, 1971
"Bank Holdings of Municipal Obligations (Fourth D istrict)"
April 5, 1971
"U nited States International Trade in Agricultural Products"
April 12, 1971
" A Note on the Current Economic S ituation"
April 19, 1971
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