Home » Business » Bank Deposits – Bedrock of Financial Intermediation [column]

A bank deposit is a placement of funds in an account with a bank or other financial institution. Bank deposits can be categorised into two types: demand deposits and time deposits. Failure to distinguish among the two types of deposits is one of the challenges bank clients face. Thus they may end up making wrong financial decisions.

Demand deposits are the placement of funds into an account that allows the depositor to withdraw his or her funds from the account without warning or with less than seven days’ notice. Usually there is no limit to the number of transactions a depositor can have on these accounts. A bank will usually levy a fee for each transaction.

A time deposit is an interest-bearing deposit held by a bank or financial institution for a fixed term whereby the depositor can withdraw the funds only after giving a pre agreed notice. Time deposits generally refer to savings accounts or certificates of deposit, and banks and financial institutions usually require notice for withdrawal of these deposits. Individuals and companies often consider time deposits as “cash” or readily available funds even though they technically are not payable on demand. The notice requirement also means that banks may assess a penalty for withdrawal before a specified date. Time deposits usually pay higher interest rates than demand deposits because they are more stable and the bank can deploy these deposits into assets such as loans.

How banks transform deposits?

Bank deposits can be made in a number of different ways. The most direct way is to walk into a bank or a bank branch in which you hold an account.

You are usually required to fill in a bank deposit slip with the particulars of your account and the amount of money you wish to deposit.

In addition, bank deposits can be made via wire transfer, as well as through a direct deposit plan from employers in many cases.

Banks provide a system where, once deposits have been placed with a bank, borrowers can access such funds.

This ensures an efficient transformation of mobilised deposits into real productive capital. The process of pooling funds lies at the core of the principal activity of banks.

Bank deposits provide a cheap and reliable source of funds for development, which is of great value developing countries, especially when the economy has difficulty raising capital from international markets.

It is very important in financial intermediation that banks should fund more of their loan book with customer deposits in order to become more robust to liquidity squeezes and contribute to the stability of the banking system.

Less deposit funding and more market funding is widely seen as negative for financial stability.

Market funding requires that the bank continually rolls over bill and bond issues and renews its borrowings from other financial institutions, in general depending on both domestic and foreign investors.

These funding sources have proved to be less stable than customer deposits, and reliance on market funding thus makes banks’ liquidity positions more vulnerable to external shocks.

In an effort to mobilise deposits in an economy, banks develop various forms of facilities that can be enjoyed by the clients.

The deposit facilities make it easier for poor clients to turn small amounts of money into “useful lump sums”, enabling them to smooth consumption and mitigate the effects of economic shocks.

It is important to keep in mind that every time you make a deposit with your bank, you are providing part of the lifeblood for the economy as deficit units of the economy are benefiting from your actions.

Putting the little resources you have under the pillow implies that you are depriving a struggling household or a firm in the economy, of a lifeline.

What are the dangers of fewer deposits?

The decline in deposits at banks raises important questions about whether banks will be able to remain successful and meet the credit needs of the economy.

Banks could experience a temporary respite due to a decline in the amount of deposits. The most important step for banks in addressing this problem would be to develop strategies that are consistent with the needs of the economy.

Banks thus need to become aggressive in maintaining their local base of depositors and the resulting customer relationships

Many banks need to look for other funding sources and to compete more directly for market based funds.

The banks need to look at ways of creating new funding sources and better ways to manage banking assets.

An option that banks can adopt is to lend on a more selective basis whenever funds are tight either, by raising credit standards or increasing loan rates and fees.

Although this strategy could result in better credit quality on one hand and perhaps higher net interest margins as loan demand increases and rates firm on the other, it could also mean curtailing the amount of credit extended to creditworthy customers.

On a broader level, this would translate to economic stagnation as some sectors will grapple with working capital and capital challenges as they fail to access loans and overdrafts from the banks while those with access to the resources fail to repay as a consequence of the high cost of the funds.

Sanderson Abel is an Economist. He writes in his capacity as Senior Economist for the Bankers Association of Zimbabwe. For your valuable feedback and comments related to this article, he can be contacted on abel@baz.org.zw .

Source : The Herald