• MPColetti

The Basic Deposit Profitability Equation



In my opinion, determining the profitability of a deposit product is a seemingly abstract concept, but can be broken down into some simple inputs if you wish to do a manual analysis or build an algorithm. With a few additional assumptions, then you can arrive at some accurate forecasting of what to expect from new initiatives using my analysis below. It is worth noting that the stand-alone value of a product should not be viewed in isolation. Certain products can serve as loss leaders if the relationship can be expanded such that the overall relationships are profitable. However, this equation is looking only at the profitability of a deposit offering.


Inputs

U = APY expressed as a decimal as an expense

V = Replacement funds cost as a decimal if brokered or borrowed as a positive for cost save

W = Interest income expectations using either base rate or blended rate from current rate sheet including any origination volume assumptions as income

X = Fee income expectations using any fees tied to product including any assumptions about fees (i.e. monthly maintenance fee)

Y = Per unit expenses (Z1 – FDIC expense, Z2 – any foreign ATM reimbursements, Z3 – core system incremental cost, Z4 – statement issuance of online banking enrollment costs, Z5 – incremental cost of any CIP or OFAC check services, etc.)

If a checking product, then: (Z6 is debit card issuance expense, X2 is anticipated interchange income)


Assumptions

A - Average new deposit amount per new unit B - New units anticipated

C - Growth rate per month or quarter as a decimal

D – Cycle time

Balance accrual assumes average daily balance calculation

W+X+X2 > U+Z1+Z2 (+Z3, Z4, Z5 is optional depending upon your strategy relating to sunk costs)


Equation

E = Volume of Deposits for period 1 = (A*B)

F = Volume of Deposits for period 2 = (A*B)*C


After Month 1

P = (F)*(U*D/365) = APY Interest expense

P1 = (F)*(V*D/365) = replacement funds cost savings, if applicable

P2 = P-P1 = Cost of funds per cycle per volume

P3 = (E+F)*(W*D/365) = interest income expectations from lending activities

Net interest income (NII) as a whole number = P3 – P2

P4 = NII – (B*(Y)) = Profitability


Profitability will grow for later quarters depending upon the growth rate associated with input F as derived from input C.

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