Deposit mix and its impact on profitability

Raghunath Pradhan

A bank is a financial institution that collects deposit and provides loans to the needy groups. The difference between the rate at which they pay to the depositor and the rate which apply to the borrowers is called interest margin, Interest margin contributes significantly on the profit of a bank.

The sole and ultimate objective of collecting deposit is to extend loan to the needy groups. So, they will be ready to collect deposit even at higher rate provided with there is demand of loan for the increased volume of deposit. 

A bank use to collect different types of deposit having different nature. Current, call, savings and fixed or termed deposit are four basic types of deposit. Current and Savings deposits are checkable accounts. So, the holders of current and savings deposit accounts may withdraw or deposit cash at any time. They can withdraw cash or transfer to the credit of another account as per their requirement without giving any prior notice to the bank remaining within their available account balance. The bank does not pay any interest on current account. So, this is the cheapest deposit to the bank. In contrast to current account bank use to pay interest on savings deposit. The purpose of current account holders is carrying transaction as per their business requirement. So, volume of transactions on current account will be very high in comparison to savings accounts. Basically, savings accounts are maintained by the individual for saving purpose and carrying household or personal transactions. For taking lending decision savings deposit is much more reliable than the current deposit.

The question may rise if there is no limitation on transaction amounts and volume both on current and savings accounts why people open current account where interest is not paid. Saving accounts are available only for the individuals and nonprofit making organization. Profit making organizations are restricted for opening saving account.

The third type of deposit account is call deposit. Call account is not checkable account so it is linked with current account for withdrawing the amount from the account. Interest is also payable on call account. As per the latest regulatory guidelines interest not exceeding 50% of lowest interest rate applicable to savings accounts may be paid on this account.

Term or fixed deposit is the fourth types of deposit account where interest is paid at higher rate. Fixed deposit account is opened for fixed period. The depositor can’t withdraw the deposited amount prior to its specified time i.e. maturity. In case of requirement prior to its maturity, the depositor has two options – cancellation of the account or raising the loan against the receipt of the deposit account. Normally, banks used to provide loan at 90% of the receipt charging higher rate over the rate applicable on the account. As per the regulatory guidelines, banks are restricted to open fixed deposit for the period less than 3 months. Normally, interest rate payables on fixed deposit vary as per its maturity period. Higher the period higher will be the rate.

There are three types of term deposit – Recurring deposit, Cumulative deposit and non cumulative deposit. Recurring deposit is a term deposit account where an account holder deposits a fixed amount of money at predefined interval, monthly/quarterly, for a definite length of time. It carry higher rate of interest and paid at its maturity in a lump sum i.e. interest and principal amount. In cumulative deposit account interest is capitalized as accrued over the period of its maturity and paid to the deposit holder in lump sum at its maturity. Due to the compounding effect, this type of account earns interest at the higher rate than the other types of deposit. The third type of term deposit is non cumulative term deposit which is very common. Interest of this account is paid at predefined periodicity i.e. monthly or quarterly as accrued.

As stated above, deposits in a commercial bank remain either in the form of demand deposit or term deposit. Demand deposit includes current (call) and savings deposit which is commonly known as CASA in banking. Deposit mix is the composition of various types of deposits and their sharing on total deposit of a bank. Current deposit is interest free deposit whereas call and savings deposit are low cost deposit. So, banks are interested to have higher amount of low cost deposit in their deposit mix in order to lower their cost of deposit and thereby having a good interest margin. The general principal of business ‘buy low and sell high’ is also holds goods for banking industry as well. However, due to severe competition banks are not in a position to increase its lending rate unilaterally. Thus deposit mix plays a vital role on the profitability of a bank.