SETTING THE RIGHT TIER PRICING

Over the past 2 days we have discussed the purpose, goal and methodology when setting deposit tiers. Tiers function as an inducement to leave higher deposit balances and are recognition that not all account holders within a deposit product are the same when it comes to interest rate sensitivity. That said, sometimes account holders are the same (about 20% of the banks we study). In cases where all deposit accounts within a class act in similar fashion (and it is a permanent characteristic), then the bank should collapse the tiers in an effort to save operational cost and customer confusion. However, in cases where the homogeneity is not permanent (such as in a growing area), then the bank should price all of its tiers the same at the lowest possible level in order to reduce funding costs. In cases where there are distinct behavioral differences between accounts, pricing should vary and increase. As an aside, there are cases where we have seen a high-balance account tier exhibits less interest rate sensitivity than a lower tier and thus deserves a lower price. While this may be the correct economic move, it is a marketing disaster, as it works against the general concept of rate setting by tier. Usually when a tier exhibits the same characteristics as the previous tier, the upper tier is priced the same. Assuming that higher balance account holders are more interest rate sensitive, then rates should be set to reflect that sensitivity in accordance with the bank's overall funding plan. In other words, the more interest rate sensitive the deposit base, the higher spread should be between tiers. A low interest rate sensitive bank may average 5bp between account tiers, while a high interest rate sensitive bank may have to spread 68bp between tiers. On average, banks generally use a 15bp pricing difference between tiers. While we are speaking of averages, when it comes to commercial money market accounts, usually a bank prices its bottom tiers ($0 and $50k) the same, while offering the largest pricing difference at the top 25% of balance holders (usually around the $100k level). A common mistake is the pricing of tiers at a larger spread on commercial accounts compared to retail. In reality, business accounts usually are less interest rate sensitive. While normally we recommend setting a higher rate as an inducement to move money to the institution, the difference in tier pricing is usually much less stark than on personal accounts. In closing, it should be pointed out that it is ironic that many banks go through the trouble of setting tiers, but fail to use this tool to their advantage in marketing to their deposit base. Banks that set tiers haphazardly or don't utilize their tiers in marketing are missing out on the major benefit of tiering. In addition to discussing some of these topics at our High Performance Bank Workshop coming up in July, our Liability Coach product can help you answer many of these questions and serve as an outsourced solution for CFOs interested in getting more out of their liability base. If you need more information, do not hesitate to contact us.