Modeling the Whole Firm: The Effect of Multiple Inputs and Financial Intermediation on Bank Deposit Rates

Abstract

Empirical studies of price competition typically analyze the direct effects of market structure, cost, and local demand on prices; this approach has been applied widely to studies of bank deposit rates. However, the theory of the banking firm suggests that substitutability between sources of deposits and conditions in the bank loan market should also affect the pricing of retail deposits. This paper develops a theoretical model to incorporate these effects, and tests the predictions empirically using institution-level deposit rate data from Bank Rate Monitor. The results suggest that the cost of largescale deposits affects how banks price retail deposits, and that conditions in lending markets feed back into retail deposit rates.

Multimarket bank pricing: An empirical investigation of deposit interest rates

“…This would imply that larger banks do not need to offer as high a retail deposit rate as do small banks, and that smaller, single-market banks would tend to offer lower deposit rates, the greater the presence of such large multimarket banks in their local areas. This explanation is consistent with the findings of Kiser (2004) in a paper that explicitly models the relationship between the cost of wholesale funds and the interest rate offered on retail deposit accounts. Rosen (2005), using a data set comprised of several large cross-sections of banks to examine the determinants of deposit interest rates, includes in his analysis variables that indicate the shares of market deposits held by banks in various size categories (regardless of whether they are singlemarket or multimarket banks).…”

Multimarket Bank Pricing: An Empirical Investigation of Deposit Interest Rates

“…This would imply that larger banks do not need to offer as high a retail deposit rate as do small banks, and that smaller, single-market banks would tend to offer lower deposit rates, the greater the presence of such large multimarket banks in their local areas. This explanation is consistent with the findings of Kiser (2004) in a paper that explicitly models the relationship between the cost of wholesale funds and the interest rate offered on retail deposit accounts. Park and Pennacchi (2003) develop a detailed spatial model of bank pricing in which they assume that multimarket banks set uniform prices across the markets they serve and that these institutions have a funding advantage relative to smaller, singlemarket banks.…”

Banking market conditions and deposit interest rates

“…Large banks may be able to exploit economies of scale and scope to achieve lower cost structures. For example, large banks may have funding or investment options not available to smaller institutions (Park and Pennacchi, 2005;Kiser, 2004). While this suggests that large banks may set different rates than small banks, the direction of the difference is unclear.…”