Barbara Bennett

English

Research Papers in Economics

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June 26, 1981 
NOW Developments 
At the end of last year, commercial banks, 
savings-and-Ioan associations and other thrift 
institutions began offering interest-bearing 
transaction accounts called NOW (nego-
tiable order of  withdrawal) accounts. Since 
then, the nature of  the competition for house-
hold checking deposits has changed dramati-
cally. No longer are banks and credit unions 
the only institutions (outside the Northeast) 
offering interest-bearing transaction ac-
counts.  With NOW accounts,  savings-and-
loan associations for the first time have an 
opportunity to compete with commercial 
banks for the checking deposits of house-
holds and nonprofit institutions-and they 
have seized this opportunity aggressively. 
In the West, NOW  balances have grown at an 
explosive rate so far this year (see chart). 
Western commercial banks, like their coun-
terparts elsewhere, have jumped to an early 
lead in the competition for market share. 
Western S&Ls, however, have gained a larger 
market share than their national counterparts, 
and have also eaten into the lead of their 
regional banking competitors. 
This intense competition will strongly affect 
banks' as well as S&Ls' profits, particularly as 
the S&Ls begin to take advantage of  their 
recently expanded asset and liability powers. 
Ultimately, this competition may cause all 
depository institutions to reevaluate and re-
price the services they offer. 
Before NOWs 
Banks nationwide have been able to offer a 
close substitute for interest-bearing transac-
tion accounts since November 1978, when 
regulatory authorities authorized use of  ATS 
(automatic transfer from savings) accounts. 
As their name implies, these accounts permit 
the transfer of funds from a depositor's sav-
ings account to cover checks drawn on a 
linked (usually zero-balance) checking ac-
count. ATS balances at first grew at an unever 
pace, however, because of  questions regard-
ing their legality. An April 1979 court ruling 
set aside the regulations authorizing ATS ac-
counts, and their status remained in doubt 
until the Monetary Control Act (MCA) legal-
ized such deposits in March 1980. 
In overall terms, ATS-balances grew substan-
tially until the beginningof 1981 (when many 
depositors converted their ATS accounts to 
NOWs), but their growth failed to match the 
spectacular growth of NOW balances in the 
first four months of 1981. "Other checkable 
deposits," which until this year included all 
ATS balances plus NOW balances at New 
England, New York and New Jersey deposit-
ory institutions, reached $26.9 billion by De-
cember 1980. Over the next four months, 
however, this category jumped to $64.5 
bi  II ion -a  140-percent increase -al  most en-
tirely because of NOW-account growth. 
Competition spurs growth 
Many factors contributed to this develop-
ment, including the greater simplicity of the 
NOW account as opposed to the ATS 
account. But another important factor was 
the S&Ls' entry into the competition for inter-
est-bearing transaction balances. The 
absence of thrift competition for ATS 
balances, in contrast, tended to reduce 
banks' incentives to offer their ATS accounts 
at attractive terms. In local markets outside 
New England and New York, many smal~ 
banks decided not to offer ATS accounts In 
earlier years because of the probability that 
their customers would not be lured away by a 
competitor's ATS service. (By contrast, most 
of  them chose to offer NOW accounts this 
year.) Most banks offering ATS imposed sub-
stantial minimum-balance requirements and 
aimed their marketing campaigns only at 
their highest-balance customers, to discour-
age thei~ zero-interest checking accounts 
from switching to 5%-percent-interest 
ATS accou nts. 
Since the first of  the year, the competition for 
interest-bearing transaction balances has in-IP\~  cdl cB 1l:J C8\ll  IRl ~  ~(~  rrw  ~ 
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tensified considerably as a result of the entry 
into the market of these new thrift-institution 
competitors. Commercial banks and thrifts 
alike, by regulation, cannot exceed a 5%-
percent interest rate on their NOW and ATS 
accounts. Thus, they have been forced to 
compete for deposits on the basis of 
minimum-balance requirements and service 
packages. 
Different incentives 
In this competitive environment, S&Ls gener-
ally offer the most attractive terms, such as 
lower minimum-balance requirements and 
comprehensive packages of related services 
(free checks, check-guarantee cards, etc.). 
They do this because, unlike banks, they view 
NOW deposits as a source of new, low-cost 
fu nds. Sixty to sixty-five percent of S&L NOW 
deposits have come from outside the industry 
(largely from commercial-bank checking or 
savings accounts) and not from thrift-
institution passbook savings. S&L executives 
are quite pleased with this development be-
cause, in spite of reserve requ i  rements and 
processing costs, these NOWfunds are much 
cheaper than funds borrowed in the money 
markets or from Federal Home Loan Banks at 
rates currently in excess of 15 percent. 
S&Ls also have been aggressive in their pro-
motional campaigns because their ability to 
offer a transaction account allows them to 
compete with commercial banks as one-stop 
family financial centers. And since conveni-
ence is a primary factor in households' deci-
sions about uses of funds, S&Ls expect to be 
able to lure other deposits, such as savings 
accounts, once they have established pri-
mary relationships with depositors. In ess-
ence, then, S&Ls may be offering attractive 
NOW-account packages today in anticipa-
tion of more profitable overall relationships 
with depositors in the future. 
The pressure of  S&L competition has induced 
commercial banks to offer more attractive 
terms on ATS and NOW accounts than they 
did when they were the only competitors in 
the field. For instance, many now offer lower 
2 
minimum-balance requirements than they 
did previously. Despite these "repricing" 
maneuvers, however, banks generally 
require higher minimum balances than S&Ls 
do, partly because they want to discourage 
their customers from shifting funds to 
higher-cost NOWs at their own institutions. 
With this strategy, of course, the banks are 
gambling that a relatively insignificant 
proportion of their customers will shift funds 
to S&Ls. To a certain extent, these differences 
in terms may also reflect differences in the 
services offered by banks and S&Ls. Banks 
generally offer more extensive branch and 
ATM (automated teller machine) networks, 
as well as broader packages of consumer 
financial services. Thus, banks can offer their 
NOW  customers a more comprehensive 
package of services-albeit at higher cost-
than can the S&Ls. As long as households 
value these other services, banks may not 
experience a significant decline in market 
share despite generally higher minimum-
balance requirements. 
Western trends 
In the Western states served by the San 
Francisco Federal Reserve District, the com-
petition for interest-bearing transaction de-
posits began to heat up long before this year's 
introduction of NOW accounts. Late last 
summer, several large banks cut the 
minimum-balance requirements on ATS ac-
counts in a successful effort to get a headstart 
on NOW-account competition. In 
November and December, depository in-
stitutions (especially S&Ls) encouraged de-
positors to open accounts that would be con-
verted to NOW accounts on January 1. All 
the larger banks and S&Ls began advertising 
in earnest in December, and this activity re-
mained intense through February. The in-
tensity of this competition helped raise con-
sumer awareness of  the advantages of 
interest-bearing transaction accounts. NOW 
balances at larger Western institutions-
those with deposits in excess of $15 mil-
lion-thus grew from $560 million in De-
cember to $4".3 billion by the end of  Jan-
uary -and  to $7.3 bi  II ion by the end of  Apri  I. ------------_.  __  .. _-----------_._------_._------
Despite the intensity of the competition, 
Western banks held the lion's share of total 
NOWs-$5.3 billion, or 72.5 percent-at 
the end of April. S&Ls, by contrast, held only 
$1.4 billion, or 19.3 percent, and credit un-
ions held the remaining $600 million. Actu-
ally, this lopsidedness in market shares is not 
surprising, since commercial-bank checking 
accounts to date have provided the primary 
source of the growth in NOW balances. 
Nonetheless, the rate of growth in Western 
S&L NOW balances has exceeded the rate of 
growth of bank NOWs and credit-union 
share drafts. Furthermore, Western S&Ls have 
outpaced their counterparts in the rest of the 
country, with a 19-percent as against a 14-
percent market share on April 29. This re-
flects the Western S&Ls extensive branch 
networks and large-scale operations, which 
permit'them to compete effectively with large 
Western banks. This is particularly true in 
California, where manyofthe nation's largest 
savings-and-Ioan associations are head-
quartered: S&Ls have gained 23 percent of 
California NOW balances, compared to 
banks' 69-percent share. 
Bottom line 
The competition for NOW balances is likely 
to affect depository institutions' profits signif-
icantly. As a group, savings-and-Ioan associ-
ations may end up as. beneficiaries of this 
competition. Nationwide surveys show that 
the average S&L NOW-account balance ap-
proximates $1800-more than enough, ac-
cording to industry estimates, to cover fixed 
processing costs, interest payments and re-
quired reserves, and still provide a positive 
$ Billions 
8 
6 
4 
2 
Western  NOW  Account 
Growth  (1981) 
spread between current loan rates and the 
cost of fu nds. And si nce 60 to 65 percent of 
their NOW balances rep~esent "new" funds, 
S&Ls can use these funds instead of higher-
cost alternatives. 
The impact of the NOW competition on 
banks' earnings is more difficultto  determine. 
On the one hand, banks have experienced a 
substantial increase in interest costs, because 
75 to 85 percent of  their NOW balances 
come from their own zero-interest checking 
balances. On the other hand, banks' efforts to 
raise charges for checking services (such as 
stop-payment orders, handling of overdrafts, 
etc.) may reduce the number of unprofitable 
accounts they hold, and thus may offset their 
NOW-related increase in interest costs. 
On NOW  accounts alone, banks should have 
no earnings difficulties; since such accounts 
apparently average close to $6,000, banks 
can easily maintain a positive spread be-
tween their loan rates and the cost of funds. 
However, the disparity between bank and 
S&L average NOW-account balances may 
suggest potential NOW-related' earnings 
problems. In view of  the S&Ls' ability to ex-
pand their market share and to obtain most of 
their NOW funds from non-S&L sources, 
banks may be losing profitable accounts to 
their thrift competitors. If this is true, banks 
are not likely to sit idle. In fact, many banks 
already appear to be reevaluating their 
minimum-balance requirements and their 
NOW-related packages of  services. The com· 
petition for NOW deposits has only just 
begun. 
Barbara Bennett 
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BANKING DATA-TWELfTH FEDERAL RESERVE DISTRICT 
(Dollar amounts in millions) 
Selected Assets and Liabilities 
Large Commercial Banks 
Loans (gross, adjusted) and investments* 
Loans (gross, adjusted) - total # 
Commercial and industrial 
Real estate 
Loans to individuals 
Securities loans 
U.s. Treasury securities* 
Other securities* 
Demand deposits - total# 
Demand deposits - adjusted 
Savings deposits - total 
Time deposits - total# 
Individuals, part. & corp. 
(Large negotiable CD's) 
Weekly Averages 
of Daily Figures 
Member Bank Reserve Position 
Excess Reserves (+  )/Deficiency (-) 
Borrowings 
Net free reserves (+  )jNet borrowed( - ) 
* Excludes trading account securities. 
#  Includes items not shown separately. 
Amount 
Outstanding 
6/10/81 
149,970 
128,013 
37,571 
52,511 
22,928 
1,675 
6,443 
15,514 
41,653 
29,224 
30,329 
80,331 
71,163 
31,081 
Weekended 
6/1 0/81 
n.a. 
173 
n.a. 
Change from 
year ago 
Change 
from 
6/3/81  Dollar  Percent 
879  12,864  9.4 
855  12,499  10.8 
- 151  3,988  11.9 
217  5,683  12.1 
22  - 959  4.0 
89  682  68.7 
55  46  0.7 
- 31  323  2.1 
- 199  2,067  - 4.7 
650  - 2,271  - 7.2 
17  2,978  10.9 
683  15,877  24.6 
- 455  15,712  28.3 
715  8,179  35.7 
Weekended  Comparable 
6/3/81  year-ago period 
n.a.  110 
124  1 
n.a.  109 
Editorial comments may be addressed to the editor (William Burke) or to the author ....  Free copies of this 
and other Federal Reserve pubikations can be obtained by calling or  writing the Public Information Section, 
Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. Phone (415) 544-2184. 

NOW developments

http://www.frbsf.org/publications/economics/letter/1981/el81-26.pdf

NOW developments

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Research Papers in Economics