How valuable is your valuation? When it comes to financial institutions valuing their core deposits, all is not necessarily equal. The Advanced Assessment Methodology (AAM) used here at MVRA applies to a wide range of circumstances, and is often the most reliable, go-to approach. However, with the idiosyncrasies between financial institutions and the records they hold making each unique in their own way, knowledge of alternative methods is key to understanding when a valuation is most accurate and beneficial.
There are several factors that might indicate the need for an alternative assessment; for example, it might be worth considering if you are able to track all your bank deposits for a fixed set of accounts over a specific time period, or whether you know the actual value of particular retained accounts. It’s worth noting that each method will have its own implications in terms of costs, meaning that different tools will apply to different budgets.
To help you understand the ideal strategy for you to value your core deposits, we will focus on two methods: the Balance-focused and Account-focused practices.
Valuation Practice – Balances
In instances where there may be a readily-available history of the deposits, for a fixed set of accounts (for any time period), financial institutions can calculate the value of their current deposits based on the monetary value of customer retention over the years.
Known as retained deposits, this ostensibly offers a fairly accurate, figure-based insight into the current value of your deposits across specific accounts, providing you with historic data to base your future financial decisions. Nonetheless, this becomes less straightforward in an absence of detailed information on those accounts and the specific time period for which those balances were held. In addition, if there are any lapses, gaps or inconsistencies in data records, then the accuracy of this method can decrease substantially.
Valuation Practice – Accounts
While the balance approach is a perfectly viable method for some, many institutions will not have a thorough enough record on retained deposits. In this case, they may rely on data from the number of deposit accounts.
This approach focuses on account retention rather than deposits. Due to the unpredictable nature of customer behavior, this method comes with a significant set of variables and might not provide accurate information on the value of balance retention—most notably where account holders may hold dormant or low-value accounts.
Which is the best practice for you?
As demonstrated, choosing the best approach to determine the value of your deposits will largely depend on your individual circumstances; your data, your customer base and a methodology which takes both into account—such as the AAM—is likely to apply to most circumstances without requiring (and incurring the cost of) deep analysis into the state of available information.
Data suggests that of the two methods (Balances and Accounts), a majority of financial institutions benefit from tracking their balance size. This is due to the fact that relying completely on retained accounts might result in under or overestimating the deposit value. Notwithstanding the few cases in which focusing on accounts might be more useful, if less accurate.
Considering the cost of carrying out a thorough analysis, the balance method is usually more apt for those specifically conducting reports to meet regulatory compliance. However, for those in the minority, where core deposits have little to no value, or the deposits are relatively homogenous, using retained accounts might constitute a sufficient strategy.
Truly understanding the option most suited to your institution for valuing your core deposits is simply not possible without a thorough analysis of where you currently stand and what those options are.
Would you like to find out more about methodologies for valuing core deposits, including how different product/account types can affect valuation accuracy? Contact our team today.
Written by Richard Sheehan, Ph.D.
About the Author
Dr. Sheehan has published in some of the leading journals in economics, including American Economic Review, Review of Economics and Statistics, Journal of Business and Economic Statistics, European Economic Review, Journal of Money, Credit and Banking, Economic Inquiry, and International Journal of Forecasting.
At MVRA his responsibility is to ensure that the analytical background of every deposit and loan study follows best practices both in terms of statistical analysis and economic theory. He also works in model validation services analyzing financial and statistical models for financial risk.