Cost of deposits measures the interest cost a bank pays for deposit funding relative to the relevant deposit balance. A common annualized form is:
Cost of deposits = Annualized deposit interest expense ÷ Average deposits
Banks may report cost for total deposits or only interest-bearing deposits. Those are different metrics because noninterest-bearing deposits can reduce the cost of total deposits without changing the rate paid on interest-bearing accounts.
Why deposit cost matters
Deposits are often a bank's largest funding source. When deposit costs rise faster than asset yields, Net Interest Margin can compress. When funding costs fall faster than asset yields, NIM can expand.
The cost of deposits also helps investors understand the economic value of a bank's deposit franchise, but the ratio should not be treated as a standalone franchise-quality score.
Example
Suppose a bank has $8 billion of average deposits and records $120 million of annual deposit interest expense.
Cost of total deposits = $120m ÷ $8.0b = 1.50%
If only $6 billion of those deposits are interest-bearing, the corresponding interest-bearing deposit cost would be:
$120m ÷ $6.0b = 2.00%
Both numbers can be correct. They answer different questions.
Average cost versus spot cost
Banks may report:
- average cost, based on expense recognized during a quarter or year and average balances; or
- spot cost, based on rates currently paid at a particular date.
Spot cost can move before the income statement fully reflects repricing. Average cost is backward-looking over the measurement period. Comparing a spot rate at one bank with an average rate at another can create a misleading conclusion.
Deposit mix matters
Deposit cost can be influenced by:
- noninterest-bearing deposit share;
- savings and money-market pricing;
- certificates of deposit and other time deposits;
- brokered or reciprocal deposits;
- public funds;
- customer concentration; and
- competitive and liquidity conditions.
A lower deposit cost can be attractive, but it is not automatically better if it is achieved by accepting unstable funding, taking concentration risk, underpaying customers in a way that causes outflows, or replacing deposits with more expensive wholesale funding.
Relationship to deposit beta
Deposit Beta focuses on sensitivity to a benchmark-rate move. Cost of deposits is the actual funding-rate level under the chosen definition. A bank can have a low current cost but a high marginal beta, or a high current cost that is repricing downward quickly.
Sources
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