Question 12.P.2: Kalewood Savings Bank has experienced recent changes in the ...

Regular and special checking accounts have declined sharply from $378 million to $235 million, while interest-bearing checking accounts rose from $287 million to $392 million. Passbook savings deposits have fallen by more than $200 million while money-market deposit accounts, retirement accounts, and both small and large ($100,000 +) CDs have all risen substantially. Management has several reasons to be concerned about these developments because the bank’s funds are shifting into accounts bearing significantly higher interest costs, while the bank is suffering substantial erosion in its core deposits represented by regular (passbook) savings deposits and small checking accounts. Thus, more interest-sensitive funds are supplanting deposits that are more loyal and less interest-elastic. The bank may find its profits are likely to be squeezed by higher interest costs and its earnings may become more volatile if market interest rates experience significant changes in the period ahead because a greater portion of the bank’s funding is coming from more interest-sensitive deposits. A possible offsetting advantage is the shift away from deposits that can be withdrawn without notice (i.e., regular and special checking accounts and passbook savings deposits) toward longer-term deposit instruments with fixed maturities, giving the bank a somewhat longer term and, perhaps, somewhat more predictable funding base.