DEPOSIT COMPOSITION AND COMMERCIAL BANK EARNINGS

Abstract

THE PURPOSE of this study is to provide quantitative estimates of the marginal net rates of return which commercial banks realize on their demand deposits, time deposits, and capital stock. To estimate these rates of return, multiple regression analysis is applied to balance sheet data on earnings, costs, deposits, and capital. The data consist of a cross section of 295 member banks in the state of Ohio for each year of the period from 1963 to 1966.1 Marginal rates of return are estimated for each of these four years. To test the possibility that net rates of return may be influenced by bank size, separate regressions are estimated for banks with total deposits of under and over 10 million dollars. Commercial banks earn a return on their deposits and capital by investing deposit-funds and capital-funds in assets. This process, of course, involves costs. Marginal rates of return are estimated net of the costs of servicing and managing assets. However, the model is specified so that the estimated coefficients on the time deposit categories do not reflect the interest costs of acquiring these deposits. For reasons discussed below, the interest costs of time deposits are presented separately. Estimated net rates of return on deposits and capital reflect the structural characteristics that prevailed during the period from 1963 to 1966. Obviously, interest rates on bank assets are an important determinant of net rates of return on deposits and capital. During this period, interest rates rose gradually.2 Covariance analysis is used below to test for year-to-year variations in net rates of return caused by increases in interest rates. In section II, the theoretical model used to estimate marginal net rates of return is developed. In sections III and IV, the data and statistical assumptions of the model are discussed. The empirical results are presented in section V. Section VI summarizes the principle findings of this paper.