Of course, having your own cost study data based on your institution is the best to use for these costs. Some of our clients have done so and have better and defensible data to use for their analysis. But if an internal study isn’t workable, it’s helpful to use a basic formula that might generate more meaningful discussion with your board and ALCO.

Borrowing from “**Managing and Pricing Deposit Services,** Rose & Hudgins, 9th ed., Chapter 12”, we can use a formula that considers costs based on the average collected balance for each account, where average collected balance = total balance minus funds that have not been collected yet by your institution.

The basic formula is a ratio of

net expenses *divided by* average collected balance * (1 – reserve requirement for that deposit type)

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#### The numerator:

[Interest Expense + Admin Costs – Service Charges – Other non-interest income + deposit insurance premium]

**Interest expense** is easy to deal with by assigning the current rate and a beta factor for moving that rate when market interest rates move.

**Administrative Costs**: This list include all kinds of “services” provided to the holders of this account type. Costs for handling withdrawals and deposits (electronic and non-electronic) per item, check cashing costs, opening/closing new accounts, monthly account maintenance costs, etc. Getting to a “per item” cost requires time allocations by staff members and average pay rates. Then, apply that to the overall portfolio.

**Service Charges & Other Non-Interest Income**: Listing by source of income the average per unit earnings levels.

__Note__: Realistically, you may want to estimate the costs and income levels to arrive at a net cost value. Document the thoughts and discuss these with the board and ALCO team for acceptance and acknowledgement. Cost study data is an expensive and time-consuming activity. As an alternative to get started, consider this approach. If you were to grow the balance and accounts by 50%, how much more staff time would be required to manage the cost? How much more non-interest income do you expect to collect? From that estimate we can back into the costs to apply as any new service may artificially have high costs until there is enough scale to lower unit costs.

**Deposit Insurance Premium**: This is a real cost to the institution. Using your regulatory requirements for insurance premiums, assign the incremental cost per $1 to the cost equation.

####

#### The denominator:

For the denominator, the current level of reserve requirements for banks is 10% of the demand deposit and checking account balances. For all other accounts, the requirement is 0%.

Let’s apply this to an example.

### Example: Interest Bearing Checking

- $2,000 average account balance
- 60 basis points Deposit Insurance premiums or $12.00 annually
- Interest expense (0.25%) is $5.00 annually
- Administrative costs estimated at $38 per year
- Non-interest income is $50 per year

The numerator formula looks like this: [5.0 + 38.00 - $50.00 + 12.00] = $5.00

The denominator looks like this: [$2,000 * (1 - 0.10)] = $1,800

The result: $5.0 / $1,800 = 0.00278 or .278% or 28 basis points

This result is 85% lower than the FFCA of 1.80% (180 basis points or 0.018), and you see that the internal calculations are usually a LONG way off from the old FFCA values. Based on an $1,800 denominator, the net numerator would have to be $32.40 not our $5.00. There’s a lot of room in between.

What would change the equation to reach that level?

- Same numerator with a $277.78 net average balances (denominator).
- Higher interest rates (numerator)
- Higher operational cost assumptions (numerator)
- Lower fee income per account (numerator)

Let’s be respectful; the old FFCA values were very good in their time. The industry needed something, and the data was sourced from banks directly. Now, if the inputs were accurate or not, we cannot ensure, but at face value, they served as a guide to measure against. But in 1991, the level of non-interest income was much lower than today. A tremendous amount of hand processing, like sending statements with cancelled checks, was the norm. But today’s world has “bent the curve” on costs, allowing for more accounts and growth without the same level of overhead managing these functions.

So take a stab with what you know using the above formula and get to a more meaningful discussion about valuing growth and managing earnings and risk to sustain your future as a community financial institution.