Deposit Franchise

A deposit franchise is the economic value a bank gains from its ability to attract and keep deposits that are cheaper and more stable than other sources of funding. Because many customers leave money in current and savings accounts that pay well below market interest rates, and do not move it even when rates rise, the bank earns a spread on those balances year after year. That persistent advantage is the franchise.

The concept is central to bank valuation, mergers and interest rate risk management. It is related to, but broader than, deposit beta, which measures how much of a rate change a bank passes on; a strong franchise combines a low beta with deposits that stay put. Its accounting counterpart in acquisitions is the core deposit intangible, and its weakness was exposed in the 2023 US bank failures, when some deposits proved far less stable than assumed.

Imagine a café on a busy street where regular customers buy coffee every morning without checking whether a café a block away is cheaper. That habit is worth a great deal: the owner can keep prices steady, plan ahead and borrow against the business, because the regulars will keep coming.

For a bank, the regulars are depositors who leave their salaries and savings in the same accounts for years, even when other banks pay a little more. The bank can lend that money out at higher rates. The deposit franchise is the value of having all those loyal, low-cost customers.

• Low interest cost. Non-interest-bearing current accounts and low-rate savings accounts cost the bank less than market funding, widening its net interest margin.
• Stability. Operational accounts used for salaries, bills and business payments tend to stay, giving the bank long-lived funding even though customers can withdraw at any time.
• Customer relationships. Customers whose main account is with the bank are more likely to borrow, use cards and pay fees there, as discussed under account dominance.
• Insurance and trust. Balances covered by deposit insurance are less likely to run than uninsured ones.

Physical branches, local market share and strong digital services all help build a franchise. Market power matters too: banks in concentrated local markets have historically paid depositors less.

Analysts judge the strength of a franchise with a handful of indicators: the share of deposits that pay no interest, the bank's average cost of deposits compared with peers, the proportion of balances below the insurance limit, the average age of accounts, and how concentrated deposits are among a few large customers or one industry. A bank with many small, long-standing retail and small-business accounts usually scores well; one dependent on a few large depositors or on rate-sensitive online savings scores worse.

Academic work by Itamar Drechsler, Alexi Savov and Philipp Schnabl has argued that the deposit franchise works as a natural hedge. When rates rise, the bank's long-term fixed-rate assets lose value, but the franchise becomes more valuable, because the gap between market rates and the rates paid on deposits widens. On this view, banks can safely hold long-dated assets funded by sticky deposits. The hedge only works if depositors stay, however. If they withdraw in large numbers, the bank must sell assets at a loss or borrow at market rates, and the franchise value disappears just when it is needed. This interplay is a core question in managing interest rate risk in the banking book.

When one bank buys another, accounting rules require the buyer to recognise identifiable intangible assets, and the core deposit intangible is usually the largest of these. It is estimated by comparing the cost of the acquired deposits, including interest and servicing costs, with the cost of replacing them with alternative funding over their expected life, and discounting the savings. The value depends heavily on assumptions about deposit runoff and future rates. Any purchase price above the value of net assets, including the deposit intangible, is recorded as goodwill. Analysts also compare bank share prices with deposit premiums paid in bank mergers to judge franchise value.

Several forces can erode a deposit franchise. Online banks and money market funds make it easier for savers to chase higher rates, and when rates rise sharply, balances shift into higher-cost products, a process described under deposit migration. Concentrated customer bases are especially fragile. Silicon Valley Bank's deposits came largely from venture-backed companies with balances far above insurance limits, and they left within hours in March 2023 once doubts spread, showing that a franchise built on uninsured deposits can be much weaker than its low interest cost suggests. Supervisors now look closely at deposit concentration, the share of insured balances and the speed at which digital withdrawals can happen.