Question

A senior bank officer has asked you to analyze the profitability of selected customer deposit relationships. The procedure is to estimate the total expense associated with account activity and compare this with projected revenues.

The typical low-balance customer at your bank with an average monthly demand deposit balance under $175 exhibits the following monthly activity: 35 withdrawals (11 electronic), two transit checks deposited, one transit check cashed, two deposits (one electronic), and one on-us check cashed per month. Assume there is one account maintenance for an account in which checks are not returned and that net indirect expenses apply.
a. Use the unit cost data to estimate the average monthly expense for the bank to service this account.
b. Suppose the bank can earn an average 6.5 percent annually on investable deposits (ledger balances minus float minus required reserves). The typical customer keeps an average monthly balance net of float equal to $116 in the account and pays a $3.25 monthly service charge. The bank must hold 10 percent required reserves against the average balance and thus can invest 90 percent of the balance. Determine whether the account is profitable for the bank.

Answer 1

To analyze a bank customer's account profitability, calculate the monthly expenses the bank incurs servicing the account against the revenues from service fees and interest earned. For the interest revenue, calculate 90% of the customer's average balance times the annual interest rate of 6.5%. The profitability analysis is incomplete without specific unit cost data, but it is crucial to also consider the bank's risk management strategies for loan defaults.

Step-by-step explanation:

To analyze the profitability of a customer deposit relationship, we must calculate both the average monthly expenses the bank incurs to provide service to the account and the projected revenues from it. The bank earns revenue from the interest it can charge by investing the deposit and from service fees. It incurs costs from the account maintenance and transactions processed.

Without specific unit cost data, we cannot calculate the part a) of the question regarding the average monthly expense. For part b), to determine profitability, we calculate the net interest income, which is the average investable balance times the interest rate, minus the reserve requirement. The monthly revenue from interest is 90% of $116 which is the investable balance, times the annual interest rate of 6.5% converted to a monthly rate. The monthly revenue from the service charge is $3.25.

The next step is to subtract the monthly expenses to find the net profit. Without knowing the unit costs, we cannot proceed to answer part a) or complete the profitability analysis in part b). Nevertheless, a bank's profitability analysis should take into account the risk of loan defaults, which can significantly affect the bank's financial stability. This is a fundamental aspect of bank management and is relevant as per the provided context on banks factoring in missing payments from loan defaults into their planning.