Money market deposit account ; Money market funds ; Bank deposits ; Interest ; NOW accounts ; Interest rates

Gary C. Zimmerman

Michael C. Keeley

English

Research Papers in Economics

FRBSF
June 14, 1985
The Big Switch
WEEKLY LETTER
The introduction ofthe m,oney marketdeposit
account (MMDA) and t~e Super-NOW account
had a major impacton the composition ofthe
portfolios ofbanks and thrifts and ofthe public
al ike. Both accounts were free of interest ceilings
and intended to be directlycompetitive with the
money marketfunds (MMFs). Ofthe two, the
limited checking MMDA, authorized on Decem-
ber 14, 1982, has been morepopular. It attracted
over $300 billion in its first three months and is
currently approaching the $450 billion level
nationally. The unlimited checking Super-NOW,
authorized on January 5, 1983, gained far fewer
deposits than the MMDA, butstill climbed to
nearly $30 billion within three months of its
authorization. Today, ithas surpassed the $50
billion level.
In this Letter, we analyze whythese new accounts
so dramatically altered both banks' and deposi-
tors' portfolios, where the staggering quantities of
funds in these accounts came from, and the
implicationsofthese accounts for banks' costs of
deposits. We focus on the MMDA because its
impacton deposit holdings was so much greater
than thatofthe Super-NOW.
When the MMDAwas introduced/some observers
thought that itwould attract large quantities of
dollars from the money funds, and there even was
speculation about the long-term viabilityofthe
consumer-oriented money funds given that
MMDAs were covered by federal deposit insur-
ance (to $100,000). Others thoughtthat most
MMDAdeposits would come from otherfunds
already on deposit at banks and thrifts. There also
were fears that iflarge amounts of low-interest
"core" deposits, such as checkingaccounts, pass-
book savings and some small denomination time
accounts, were transferred intoMMDAs, bank
and thriftdepositcosts would rise substantially.
Nowthatover two years ofdata on MMDAs and
Super-NOWs are available, these questions can
be answered. By analyzingthe magnitudeofthe
declines in other types ofdeposits and in money
funds' assets that were contemporaneous with the
MMDA'sand Super-NOW's initial rapid growth, it
is possible to infer approximatelywhich types of
funds were the most importantsources ofthe new
accounts'deposits.
What we expected
Binding deposit rate ceilings on retail accounts
had two majoreffects, both ofwhich, in theory,
led to higher deposit costs for banks and thrifts
than direct"price," i.e., interest rate, competition.
First, they caused depositoryinstitutions(hereafter
referred to as banks) to compete for retail deposits
thatweresubjectto interest rate ceilings bypaying
implicit interest in the form offree or underpdCfed
services in lieu ofexplicit interest. Second, they
led banks to substitute more expensive ceiling-free
wholesale deposits such as large ($100,000 and
over) certificates ofdeposit-orCDs-forthe
regulated retail deposits that had been moved out
ofthe banking sector into higher paying invest-
ments such as the money funds.
Thus, when the two ceiling-free accounts were
authorized, we expected thatthe lowertotal per
dollar costs ofdeposits for banks and increased
returns for depositors would act as strong incen-
tives for banks to attract funds into those accounts
and for depositors to shift funds into them.
Where would the funds forthe new accounts
comefrom? In general, weexpected fundstocome
from otherfinancial instruments thatwere close
substitutes from both banks' and depositors' per-
spectives for regulated retail deposits. Sinceopen-
market interest rates had been above deposit-rate
ceilings for a numberofyears when the new
accounts were first introduced, depositors who
didnotvaluethe implicitinterestin termsofadded
services would already have moved theirfunds
outofthe low-paying retail accounts. Thus, it
seemed unlikelythere would be a further shiftof
funds outof low-interest retail deposits, such as
passbook savings, into MMDAsorSuper-NOWs.
Instead, we expected thatthe funds, particularly
for MMDAs, which have limited value as trans-
action accounts, would come from those sources
to which depositors had moved them in the first
place to avoid the ceilings. We thus expected
particularly large inflows into MMDAsfrom the
money funds. Moveover, since banks had usedFRBSF
large CDs to replace lost retail deposits, we ex-
pected declines in the balances of large CDs as
well. Also, the ceilings had induced depositors to
move short-term funds into longer term near-
ceiling-free accounts, such as the six-month
money market certificate. We therefore expected
that the liquidity and ceiling-free natureofthe
MMDAwould inducedepositors to movefunds
from such accounts to the new MMDA.
For Super-NOWs (which have turned outto have
average account balances over $12,000), we
expected funds to come from other large-balance
transaction accounts, since individual holders of
large accountswere affected most bythe interest
ceilings. Depositors with small transaction
accounts would not be affected in the same way
because they usually had to pay fees on accounts
even with interest ceilings. Thus, on small
accounts, the ceilings were not binding because
banks were free to increase the netyield on those
accounts by loweringthe servicefees theycharged.
What we found
In Charts 1and 2, MMDAandSuper-NOWdepos-
its are plotted against otherdeposits and money
fund assets, to indicate qualitatively which types
ofbalances fell as the new accounts grew. We
inferthatthose balances thatdeclined were likely
sources ofthe newdeposits. Also, monthly chan-
ges in various deposittypes overthe first six-month
periodfollowingtheirintroduction were analyzed
statistically using a regression model to provide
quantitativeestimatesofthe sources ofthedeposit
inflows. In all ofouranalysis, weare lookingatthe
net, final effects ofdeposit shifts, and not neces-
sarily direct shifts as often measured in surveys.
Chart 1 shows a substantial decline in the money
marketfunds' assets that coincided with the
growth in MMDAs. This suggests that the money
funds were, as expected, substitutes for MMDAs
and thus importantsources ofMMDAdeposits.
Similarly, ourregression model shows astatistical-
ly significantdecline of24 cents in money fund
assets associated with each dollar inflow into
MMDAs. Although ouranalysis suggests that the
moneyfunds were an importantsource ofMMDA
deposits, the money attracted from MMFs did not
lead toacomparable increase inthetotal deposits
ofthebankingsector. As Chart 1shows, therewas
at mostonlyaslightincrease intotal deposits after
December 14, 1982.
Since total deposits did not increase by anywhere
near as much as the moneyfunds' assets decline
(see Chart 1), inflows intoMMDAsfrom the money
funds must have been mostly offset byoutflows
from other types ofdeposits. In particular, we
would expect some ofthe funds invested in large
CDsto leavethe bankingsector as MMDAdeposits
increased. In part, this would reflect the money
funds liquidation oftheir holdings ofCDs as they
shrank in size.
In addition, as banks experienced rapid inflows
into MMDAs, they reduced their purchases of rel-
ativelymoreexpensivewholesaleCDs byoffering
less attractive terms. This prompted some holders
ofCDstotransfertheirfunds elsewhere. As Chart2
shows, there was a decline in large time deposits
(CDs) of42 cents foreach $1 increase in MMDAs.
This decline in large CDs was, however, larger
than the inflow from the money funds.
The rather massive substitution of retail MMDAs
forwholesaleCDs has importantcost implications
for banks. Since MMDAs, with the exception of
the first few months after introduction, generally
have been less costly than large CDs, this shift
lowered banks' depositcosts-just as the theory
predicted.
There are implications forthe long-run viabilityof
moneyfunds as well. Although we estimate that
MMDAs attracted nearly $90 billion from the
moneyfunds, this appears to have been a one-time
shift because the moneyfunds have sincegrown
in the face ofcontinued competition from the
MMDA. Indeed, MMFassets have rebounded and
are now nearly at their pre-MMDA peak.
As MMDAs surged, there was also a dramatic
declineof52 cents for each dollar increase in
MMDAs in small-denomination (less than
$100,000) time deposits, including retail repur-
chase agreements. Afteran actual declineofnearly
$150 billion over a six-month period, small time
deposits resumed their trend growth rate as the
growth in MMDAs tapered off, suggesting that a
one-time shiftoffunds occurred (see Chart 2).
The largestdecline in this small timecategorytook
place in the popularsix-month moneymarketcer-
tificate, which already paid a near open-market
rate ofinterest buttied upfunds for six months.
The impacton the costoffunds ofthe switch fromLarge Time Deposits
($100,000 and over)
."...".
'y=::~:==:
tMD::per NOWs
December 1982
----" .... Savings Deposits
400 ........ ,- ..... ...., ........_-x,..·- .".,0 ..... _
_ .-............-.-.,.,
800
200
600
$ Billions
1000
0'-----_ __1.__---'-__--'---__""-_-----'__--'
As might be expected from theirunlimited check-
ing privileges, our analysis indicate~ thatthe only
significant source offunds for Super-NOW ac-
counts was other transaction accounts. Our statis-
tical results indicate that Super-NOWs were close
substitutes for pre-existingtransaction accounts.
Although this switch certainly increased banks'
explicit interest costs, in the long run this increase
wiII be offset by reductions in the costofattracting
checking and NOWdeposits with underpriced
services.
Conclusions
MMDA deposits came primarily from money
fu nds, small timedeposits and largeCDs. Although
MMDAs attracted about one fourth oftheir initial
deposits-approximately $90 billion-from the
money funds, the moneyfunds are now prosper-
ing despite their initial losses. The fact that the
money funds only lost afraction oftheirdeposits
to the MMDAs suggests thatthe money funds and
MMDAs are substitutes, but notthe close sub~ti­
tutes some had anticipated.
To the extentthat banks' primary comparative
advantage is in providing intermediation services
atthe retail level, the MMDAs (and to a lesser
extent, Super-NOWs), have enabled banks in the
aggregate to strengthen greatly their competitive
position by providingthem with a more stable and
lowercostsourceofdeposits. Depositorstoo have
benefitted by being offered a more valuable com-
bination ofexplicit interest, liquidity and implicit
services than had existed previously.
GaryC. Zimmerman and Michael C. Keeley
Chart 2
Selected Components of Total Deposits
(Combined Bank and Thrift Totan
....
""../0'
.,.._0
\ ..'
'Tot~1 Deposits
less MMDAs
and Super NOWs
Chart 1
MMDAs, Money Market Funds,
and Total Deposits
(Combined Bank and Thrift Total)
I
December 1982
500
2000
J- ,.-- .... ,- ___---------J
O~=:...--I.-----'-----'-------''"---------'~---l
Both passbook savings (at the time, passbook
accounts paid 5 1/4 percent at banks and 5 1/2·
percent at thrifts) and transactions balances, such
as demand deposits and NOWaccounts, also
appeared tofall slightlyduringthe monthsfollow-
ingthe authorization ofthe MMDA. However,
there is nostatistical evidenceofasignificantshift,
perhaps because the decline just mirrored the
build-ups in both savings (evident in Chart 2) and
transactions balances in the weeks preceding the
authorization ofthe MMDA. Knowing that banks
wouId be allowedtoofferthese short-term market
rate accounts as ofDecember 14, manydepositors
with maturing investments probably held funds
temporarily in transaction orsavings accounts
untilthe new accounts were available.
SBillions
2500
Although individual banks mayhave had different
experiences, our analysis suggests no significant
shift from low-interest passbook savings accounts
to MMDAs. This confirms our hypothesis thatthe
gradual erosion ofdeposits in these accounts had
left mainly depositors that preferred having interest
in implicitforms that, unlikeexplicit interest,
escaped taxation.
small time accounts to MMDAs was probably not
large for many institutions. Nearly all ofthe funds
in the small-time category were already paying
near open-market rates orwere tied to these rates
by the end of 1982. Still, even though this switch
did notdirectly alterthe costofthese funds sub-
stantially, itchanged the overall composition of
deposits and shortened the (stated) maturity distri-
bution of retail deposits.
1979 1980 1981 1982 1983 1984 1979 1980 1981 1982 1983 1984
Opinionsexpressed in this newsletterdo not necessarily reflect theviews of themanagementofthe Federal Reserve Bank ofSan
Francisco, orofthe Board ofGovernorsofthe Federal Reserve System.
Editorial commentsmay beaddressedtotheeditor(GregoryTong) ortotheauthor....FreecopiesofFederal Reserve publications
can beobtainedfrom the Public Information Department, Federal Reserve BankofSan Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.uo~6U!450m 40~n U060JO 0POJ\0U
040PI !!omoH O!UJOdJlO) ouozPl::J 0>150Il::J
OJSIJUOJ:J UOS
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and Liabilities
Large Commercial Banks
Amount
Outstanding
5/29/85
Change
from
5/22/85
Change from 5/30/84
Dollar Percent7
Loans, Leases and Investments1 2 191,043 - 734 11,495 6.4
Loans and Leases1 6 172,667 - 583 12,353 7.7
Commercial and Industrial 52,128 - 153 3,092 6.3
Real estate 62,990 - 28 2,792 4.6
Loans to Individuals 34,140 99 6,134 21.9
Leases 5,362 2 377 7.5
U.S. Treasury and Agency Securities2 11,398 - 151 - 556 - 4.6
Other Securities2 6,978 2 - 301 - 4.1
Total Deposits 194,519 2,066 6,859 3.6
Demand Deposits 45,543 1,894 1,024 2.3
Demand Deposits Adjusted3 -28,772 - 42 1,047 3.7
OtherTransaction Balances4 13,086 - 15 970 8.0
Total Non-Transaction Balances6 135,889 186 4,862 3.7
Money Market Deposit
Accounts-Total 43,540 163 4,167 10.5
Time Deposits in Amountsof
$100,000 or more 38,462 107 - 945 - 2.3
Other Liabilities for Borrowed MoneyS 22,163 -2,009 2,319 11.6
Two Week Averages
of Daily Figures
Reserve Position, All Reporting Banks
Excess Reserves (+)/Deficiency(-)
Borrowings
Netfree reserves (+)/Net borrowed(- )
Penod ended
5/20/85
65
52
13
Penodended
5/06/85
6
49
42
1 Includes loss reserves, unearned income, excludes interbank loans
2 Excludes trading accountsecurities
3 Excludes U.S. governmentand depository institution deposits and cash items
4 ATS, NOW, Super NOWand savings accounts with telephone transfers
S Includes borrowingvia FRB, TI&L notes, Fed Funds, RPs and other sources
6 Includes items notshown separately
7 Annualized percent change

The big switch

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The big switch

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