Accumulated deposit beta

What Is Accumulated Deposit Beta?

Accumulated deposit beta is a metric used in banking and asset-liability management to measure the cumulative responsiveness of a bank's deposit rates to changes in a benchmark interest rate, typically the federal funds rate. Unlike a single-period deposit beta, which assesses sensitivity over a short timeframe, the accumulated deposit beta provides a broader view of how deposit costs evolve over an extended period, such as an entire monetary policy tightening or easing cycle. This metric is crucial for financial institutions to understand their funding costs and manage net interest margin, a key determinant of bank profitability.

History and Origin

The concept of deposit beta emerged as banks increasingly needed to understand how their liabilities reacted to market interest rate fluctuations. Historically, deposit rates, particularly on core deposits like checking and savings accounts, were often "sticky"—meaning they changed slowly relative to movements in benchmark rates set by central banks like the Federal Reserve. This stickiness provided a stable and low-cost funding source for banks. However, as financial markets evolved, competition for deposits intensified, driven by factors such as increased transparency in interest rates and the rise of alternative savings vehicles like money market accounts and certificates of deposit.

The need to analyze this evolving responsiveness, especially over prolonged periods of interest rate changes, led to the development of cumulative or "accumulated" deposit beta calculations. Research from institutions like the Federal Reserve Bank of New York has extensively analyzed deposit betas across different interest rate cycles, highlighting how these betas can vary significantly based on market conditions, bank-specific factors, and the behavior of depositors. For example, analysis of tightening cycles since the 1990s reveals that cumulative deposit betas have fluctuated, with peak betas falling by about 30% since the 2000s in some instances, reflecting shifts in market dynamics and bank funding strategies.

²⁹## Key Takeaways

• Accumulated deposit beta measures the cumulative change in a bank's deposit rates relative to a benchmark interest rate over a period.
• It is a vital tool for banks in managing interest rate risk and assessing the sensitivity of their funding costs.
• A higher accumulated deposit beta indicates that a larger proportion of benchmark rate changes are being passed on to depositors.
• This metric is particularly relevant during prolonged periods of monetary policy tightening or easing.
• Factors like competition, market liquidity, and deposit mix can significantly influence a bank's accumulated deposit beta.

Formula and Calculation

The accumulated deposit beta is calculated as the total percentage change in a bank's average deposit rate over a defined period, divided by the total percentage change in a benchmark interest rate (such as the federal funds rate) over the same period. This cumulative measure provides insight into the long-term pass-through of policy rate changes to deposit costs.

The formula can be expressed as:

For example, if the federal funds rate cumulatively increased by 525 basis points (bps) during a tightening cycle, and a bank's average interest-bearing deposit rate cumulatively increased by 275 bps over the same period, the bank's accumulated deposit beta would be:

This means that approximately 52% of the change in the benchmark rate was passed on to depositors. T²⁸he calculation often uses data from regulatory filings to infer annualized rates paid on deposits relative to total interest-bearing deposits.

²⁷## Interpreting the Accumulated Deposit Beta

Interpreting the accumulated deposit beta involves understanding its implications for a bank's financial health and strategic positioning. A high accumulated deposit beta signifies that a bank is quickly and significantly passing on changes in the benchmark rate to its depositors. In a rising rate environment, this means higher funding costs for the bank, potentially compressing its net interest margin. Conversely, in a falling rate environment, a high beta would mean rapidly declining deposit costs, which is beneficial for the bank.

A low accumulated deposit beta, on the other hand, suggests that the bank's deposit rates are less responsive to market changes. During periods of rising rates, this is advantageous for banks as their deposit costs remain relatively stable and low, contributing to margin expansion. H²⁵, ²⁶owever, in a declining rate environment, a low beta could mean slower reductions in deposit costs, potentially making the bank's offerings less competitive compared to peers that adjust rates more quickly. Banks with a high proportion of stable, low-cost core deposits typically exhibit lower betas.

²³, ²⁴## Hypothetical Example

Consider a regional bank, "Horizon Bank," during a multi-year period where the Federal Reserve raises the federal funds rate by a cumulative 400 basis points (4.00%). Over this same period, Horizon Bank's average rate paid on all interest-bearing deposits increases by 180 basis points (1.80%).

To calculate Horizon Bank's accumulated deposit beta:

• Cumulative Change in Average Deposit Rate = 180 bps
• Cumulative Change in Federal Funds Rate = 400 bps

This 45% accumulated deposit beta indicates that, over the entire tightening cycle, Horizon Bank passed on 45 cents of every dollar increase in the federal funds rate to its depositors. This figure can then be compared to industry averages or competitor betas to assess Horizon Bank's deposit pricing strategy and its impact on its balance sheet and profitability.

Practical Applications

Accumulated deposit beta is a critical component of asset-liability management (ALM) for financial institutions. Its practical applications include:

• Profitability Forecasting: Banks use accumulated deposit beta to forecast future net interest margin under various interest rate scenarios. A clear understanding of how deposit costs will respond to changes in the yield curve is vital for accurate financial projections.
• Strategic Pricing: The metric helps banks strategically price their deposit products. Institutions can analyze their beta relative to competitors to determine if they are leading or lagging in rate adjustments, influencing their ability to attract and retain deposits.
  *²² Risk Management: It assists in managing interest rate risk and liquidity risk. By understanding the sensitivity of their funding base, banks can better prepare for potential shifts in funding costs and deposit outflows, particularly during periods of rapid monetary tightening.
  *²¹ Regulatory Compliance: Regulators often scrutinize deposit betas as part of their assessment of a bank's balance sheet resilience and interest rate risk exposure. Proactive ALM practices, informed by deposit beta analysis, are crucial for maintaining sound operations.
  *²⁰ Capital Planning: Insights from accumulated deposit beta contribute to robust capital adequacy planning by enabling banks to model the impact of interest rate movements on earnings and capital. During the recent rate hike cycle from February 2022 to July 2023, the Federal Reserve raised the upper limit on the federal funds rate by 525 basis points, forcing banks to manage the effects on their balance sheets. B¹⁹anks that strategized successfully understood deposit betas and their impact.

¹⁸## Limitations and Criticisms

While valuable, the accumulated deposit beta has several limitations and criticisms:

• Historical Basis: The calculation relies on historical data, which may not always accurately predict future deposit behavior. F¹⁷actors such as technological advancements, social media influence, and changing customer expectations can alter deposit sensitivity in ways not fully captured by past trends. F¹⁵, ¹⁶or instance, the 2023 banking turmoil demonstrated how social media could accelerate deposit runs, challenging traditional assumptions about deposit stickiness.
  *¹⁴ Varying Behavior Across Cycles: Deposit betas can vary significantly across different interest rate cycles. As noted by the Federal Reserve Bank of New York, betas in the 2004 rate cycle peaked higher than those in the post-financial crisis cycle (2015-2019), and even the most recent cycle (2022-2023) showed unique characteristics due to the speed and magnitude of Fed actions.
  *¹¹, ¹², ¹³ Product and Customer Segmentation: A single aggregated accumulated deposit beta might obscure important nuances. Deposit betas typically vary by product type (e.g., checking, savings, time deposits) and customer segment (e.g., retail vs. commercial), with more liquid accounts generally having lower betas and commercial deposits often showing higher sensitivity.
  *⁹, ¹⁰ Non-Rate Factors: Deposit behavior is influenced by more than just interest rates. Factors such as a bank's brand reputation, customer loyalty, digital banking capabilities, and the availability of competing investment opportunities (like money market funds) also play a significant role.
  *⁷, ⁸ Zero-Lower-Bound Issues: The concept of deposit beta becomes less useful when benchmark interest rates are near zero, as banks have limited room to lower deposit rates further.

⁶## Accumulated Deposit Beta vs. Deposit Beta

While closely related, "accumulated deposit beta" and "deposit beta" refer to distinct measurements of deposit rate sensitivity.

• Deposit Beta (or Spot Deposit Beta): This is the more common, instantaneous measure. It quantifies the responsiveness of a bank's deposit rates to a change in the benchmark interest rate (e.g., the federal funds rate) over a specific, short period, often following a single rate change by the central bank. For example, if the Fed raises rates by 25 basis points and a bank raises its deposit rates by 10 basis points, the deposit beta for that instance is 0.40 or 40% (10/25). T⁵his figure reflects the immediate pass-through of a rate change.
• Accumulated Deposit Beta: As discussed, this is a cumulative measure that sums up the changes in deposit rates and benchmark rates over an extended period, such as an entire interest rate cycle (e.g., a series of hikes or cuts). It provides a holistic view of how a bank's funding costs have responded throughout a complete phase of monetary policy. The accumulated deposit beta helps in assessing the overall "stickiness" or responsiveness of a bank's deposit base over time, which is particularly relevant for long-term asset-liability management and strategic planning.

The key difference lies in the timeframe and the cumulative nature of the latter, providing a broader, more historical perspective on deposit cost behavior.

FAQs

How does the Federal Reserve's actions influence accumulated deposit beta?

The Federal Reserve's adjustments to the federal funds rate directly impact the benchmark against which deposit betas are measured. When the Fed raises rates, banks face pressure to increase their deposit rates to remain competitive and retain funds, leading to a higher accumulated deposit beta over the tightening cycle. Conversely, during periods of rate cuts, banks tend to lower deposit rates, which would affect the accumulated beta over that cycle.

³, ⁴### Why do some banks have a lower accumulated deposit beta than others?
Banks with a higher proportion of "sticky" deposits, such as non-interest-bearing checking accounts or stable retail savings accounts, typically exhibit a lower accumulated deposit beta. These deposits are less sensitive to interest rate changes because customers value convenience, loyalty, or integrated banking services over maximizing interest income. Ample liquidity and less intense competition can also contribute to lower betas.

¹, ²### Is a high or low accumulated deposit beta better for a bank?
It depends on the interest rate environment. In a rising rate environment, a lower accumulated deposit beta is generally favorable for a bank, as it means their funding costs increase more slowly, supporting a stronger net interest margin. In a falling rate environment, a higher beta would be beneficial, allowing the bank to quickly reduce interest expenses. The "ideal" beta depends on a bank's overall asset-liability management strategy and its outlook on future interest rate movements.