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Understanding Bank Deposits – The Rate You See Versus the Rate You Earn

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Public officials are expected to seek the best available returns while maintaining the safety and liquidity of funds when investing stakeholder dollars. However, that can be challenging when comparing returns on cash on deposit with a bank against investment alternatives for those balances.

Many banks offer compensation to their institutional depositors through an earnings credit rate (ECR). This rate is typically set by the bank and determines the dollar value of credits earned on available or "compensating" balances. In most cases, earnings credits can only be used to pay the bank for services utilized.

When evaluating options for cash balances, it is important to understand the mechanics of the ECR offered. Due to bank fees and adjustments to the way ECRs are calculated, the actual return on deposits may not match the rate published on statements.

In order to accurately compare the ECR relative to other alternatives, it is important to look not only at the stated rate but also at associated fees on deposit balances. Most banks assess a monthly fee on the value of deposits maintained. This deposit-based fee is identified on the monthly invoice or account analysis statement provided by the bank, with each bank using a unique name for the charge.

Examples of deposit-based fees include:

Deposit Administration Fee

Recoupment Monthly Fee

Deposit Bank Assessment

Banks may also impose a reserve requirement, which can effectively reduce the balance available to generate earnings credits by as much as 10%. Deposit-based fees and reserve requirements should be considered because each can considerably decrease the effective earnings on bank deposits. In a low-interest-rate environment, fees on deposited balances may exceed the bank's compensation, resulting in a negative effective rate on balances despite the stated rate being positive. Consequently, it is important to compute the "net" ECR and compare the "net" rate to alternative investment options.

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The tables above demonstrate the profound effect a deposit-based fee and reserve requirement can have on the generated earnings credit. The table on the left calculates an ECR with no deposit-based fee/reserve requirement. The bank's stated rate of 0.25% matches the effective rate on collected balances.

Meanwhile, the table on the right depicts an ECR impacted by a 10% reserve requirement and a deposit-based fee of approximately 0.10%. The bank's rate of 0.25% is drastically reduced to an effective rate of just 0.125% on collected balances.

 

Comparison Tips:

Check to see if the bank is imposing a deposit-based fee (e.g., Deposit Administration Fee, Recoupment Monthly Fee, Deposit Bank Assessment).

Inquire if the bank is imposing a reserve requirement. If so, remember that this lowers the balance available to generate earnings credits.

 

How PFM Can Help:

As you seek to fully understand your compensating balances and optimize your organization's earnings on deposit balances, PFM's experienced professionals can assist. PFM is a leading provider of investment advisory services to the public sector.

We are not affiliated with any bank or trust company; as fiduciaries, we provide independent, objective advice.

For more information about PFM, or any information in this article, please contact your local PFM relationship manager.