What it means
Not all deposits behave the same way. A local business current account that has run for eleven years and pays for payroll every fortnight is very different from a $2,000,000 certificate placed by a deposit broker chasing the highest rate in the country.
The first will still be there next year almost regardless of rates; the second leaves the moment a competitor offers ten basis points more. The usual definition takes total deposits and strips out the volatile parts: brokered deposits, large time deposits above the insured limit, and out-of-market money gathered through rate comparison sites.
What remains is the core, and the ratio of core deposits to total deposits is a headline measure of funding quality. Higher is safer, and banks with a low ratio depend on markets that can close exactly when they are most needed.
Core deposits are also the main reason a bank earns anything. Because these balances pay little or no interest, they widen net interest margin, which is the gap between what a bank earns on loans and what it pays on funding.
A bank funded at 1.2% while a rival funds at 4.5% can lend at the same rate and still be far more profitable. The stability assumption is not unconditional, and recent banking history has made supervisors more careful about it.
Deposits that are uninsured, concentrated in a single industry, or held by customers who can move money instantly through an app can leave much faster than traditional models assumed. Analysts now look at insured proportion, customer concentration and average relationship length rather than treating all retail balances as equally sticky.
Because core deposits are so valuable, they carry a price in acquisitions. When one bank buys another, part of the goodwill paid reflects a core deposit intangible, an estimate of the value of funding cheaply for years rather than borrowing at market rates.
That intangible is then amortised over the expected life of the relationships.
In practice
Real-world examples.
Example
A rural bank with a 90% core deposit ratio sails through a period of rising rates because its customers keep their current accounts where their local branch is. A competitor funded largely by brokered certificates has to raise its rates sharply to retain balances, and its margin narrows by more than a percentage point.
Example
An acquiring bank pays a premium for a target with $800,000,000 of long-standing retail deposits and books part of that premium as a core deposit intangible. The intangible is amortised over ten years, reflecting how long those relationships are expected to last.
Example
A digital bank grows deposits quickly by topping the comparison tables, then discovers during a rate cut that a third of its balances leave within two months. Its supervisor requires a larger liquidity buffer because so little of the funding qualifies as core.
Formula
Calculation
Core deposits = Total deposits - Brokered deposits - Large time deposits above the insured limit - Out-of-market and other volatile deposits. Core deposit ratio = Core deposits / Total deposits.
A community bank reports total deposits of $2,400,000,000. Of these, $180,000,000 came through deposit brokers, $220,000,000 sit in time deposits above the $250,000 insured limit, and $100,000,000 were gathered from out-of-market savers through comparison websites, which is $180,000,000 + $220,000,000 + $100,000,000 = $500,000,000 of volatile funding. Core deposits are therefore $2,400,000,000 - $500,000,000 = $1,900,000,000, and the core deposit ratio is $1,900,000,000 / $2,400,000,000 = 79.2%. If the bank replaced $100,000,000 of wholesale funding costing 4.5% with core deposits costing 1.2%, it would save 3.3% x $100,000,000 = $3,300,000 of interest a year.Case study
Seen in the real world.
Ridgeway Community Bank is an illustrative and entirely fictional lender that had grown its balance sheet from $1,600,000,000 to $2,400,000,000 in three years. Most of that growth came from a national savings platform, and management reported it simply as deposit growth in board packs, celebrating a funding base that looked healthy in total.
A new treasurer rebuilt the analysis and found that of $2,400,000,000 of deposits, only $1,900,000,000 met the core test, and that the entire increase of the previous eighteen months was rate-sensitive money. Modelling a 1% rate rise by competitors suggested $320,000,000 could leave within a quarter, against on-balance-sheet liquid assets of $260,000,000.
In this fictional scenario the board slowed lending growth, raised its liquid asset buffer, and paid relationship managers on core deposit growth rather than total balances. Two years later total deposits had grown more slowly, to $2,550,000,000, but the core ratio had improved to 88%, and the cost of funds had fallen despite a higher rate environment.
Watch out
Common mistakes.
- Judging a bank's funding by total deposits alone. Two banks with identical deposit totals can have completely different risk profiles depending on how much of the money is core.
- Assuming all retail balances are sticky. Uninsured balances, single-industry concentrations and app-based customers can move far faster than traditional behavioural models assume.
- Chasing deposit growth through comparison sites without pricing the risk. Rate-shopping money is expensive to keep and typically requires a larger liquidity buffer behind it.
Questions
People also ask.
Why are core deposits described as cheap funding?
Because current accounts and small savings balances pay little or no interest, so they fund lending at a far lower cost than wholesale borrowing or brokered certificates.
What counts as a non-core deposit?
Broadly, brokered deposits, large uninsured time deposits and money raised outside the bank's natural market, all of which tend to leave when rates change.
What is a core deposit intangible?
It is the value an acquirer assigns to a target's stable, low-cost deposit relationships, recognised as an intangible asset and amortised over their expected life.
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