Tracking Community Banks’ Cost of Funding Trends

Deposit Management

Every year we analyze the historical cost of funding earning assets (COF) for all banks in the country.  We perform this analysis on every bank from 1990 to the present to understand the drivers of COF, how banks can improve performance by controlling their COF and how funding costs will behave in the future.


We examined 5,412 banks at the end of 2018 (commercial, savings banks, and S&L associations).  We excluded a handful of unusual institutions under $5mm in assets.  We compared the quarterly COF for these banks to 3-month T-Bills, Prime and 1-month LIBOR.  We also looked at the best fit for the lag between COF and these three indices.  Finally, we analyzed the information based on the banks’ asset size.

First, between the three indices that we considered (Treasury Bills, Prime and 1-month LIBOR) the correlation between all banks and COF appears in the table below.  All three indices are almost 99% correlated.  However, 1-month LIBOR is a slightly better fit for all banks’ COF.  Prime was less correlated between the three.  Nonetheless, the correlation between all three indices and COF is very close.

Index Correlations to Bank Cost of Funds

 Second, we looked at the best fit for the lag between the indices and banks’ COF.  Because the change in interest rates take time to affect banks’ COF, we considered various time lags to determine most correlative data series.  It appears that it takes nine months for changes in interest rates to translate fully on COF.   We recognize that we are measuring correlation and not causation and there are many variables that we cannot control that will dictate the lag between interest rate changes and COF changes.

Index and Lag Correlation

 Finally, we looked at the correlation between COF and 1-month LIBOR for banks in various asset classes.  Smaller and larger sized banks exhibit a very similar correlation between all three indices and their COF.  While this may appear odd at first because community banks do not typically price deposits to LIBOR, Treasuries, or Prime, the results, nonetheless, are intuitive.  Because larger banks do price their deposits to LIBOR and make extensive use of funds transfer pricing (FTP), and because the larger banks comprise such a dominant share of the deposit market, all banks in the country are simply following the general pricing set by the national banks.  The top 10 largest banks in the country control approximately 51% of deposits and the top 50 largest banks in the country control approximately 74% of deposits.  We would postulate that banks over $10B in assets (about 135 banks in the country that control approximately 84% of deposits) are all judiciously adhering to FTP.  Therefore, the bank deposit market for small and large banks alike is strongly correlated to all three indices we considered.

 Index Correlation for Bank Funding

Graphically the average bank’s COF looks like the graph below as compared to 1-month LIBOR with a 9-month lag.

Average Bank Cost of Funds Correlations

We can also run the data for an individual bank in the country, and CenterState’s results appear below.

CenterState Bank COF Correlation Graph Showing 0.88

How to Apply to Your Bank

 First, despite surprise by some bankers, the COF for community banks is highly correlated to Treasuries, Prime, and LIBOR even though community banks do not expressly price their deposits or liabilities to any of these indices.  Second, the best-correlated index for community banks’ COF is 1-month LIBOR.  Third, the best correlation adjusted for lag is nine months.  We believe that banks’ COF will continue to rise well past the last interest rate increase. However, we note that this lag is dependent on many factors such as the rate of interest rate increases, the starting point for interest rate increases, and many competitive factors.  Banks should expect their COF to continue to increase throughout the year even if the Federal Reserve does not increase interest rates until the end of this year. Fourth, please let us know if you want us to run the COF graph for your bank – we already have the database built and would be glad to generate and send you the graph output.