CONSUMER SWITCHING
COSTS AND FIRM PRICING:
EVIDENCE FROM BANK
PRICING OF DEPOSIT
ACCOUNTS
By Timothy H. Hannan
This paper employs extensive information on
bank deposit rates and county migration
patterns to test for pricing relationships
implied by the existence of switching costs.
It relies on the following propositions:
1.Banking markets are local.
2. Existing customers incur switching cost to
open accounts at new banks, but in-migrants
do not face switching costs relevant to their
choice of bank.
3. Banks view the time that an in-migrant can
be expected to stay in the area as relevant to
the pricing decisions that they make to attract
new customers.
Preview of Results
1. Because some areas experience more inmigration than others, banks, in
addressing the tradeoff between attracting
new customers and exploiting old ones,
offer higher deposit rates in areas (and at
times) characterized by greater inmigration.
Preview of Results
2. Because out-migration implies that on
average a locked-in customer will not be
with the bank as many periods, greater
out-migration changes the bank’s
assessment of this trade-off such that the
bank offers lower deposit rates in areas
(and during periods) that experience
greater out-migration.
Preview of Results
3. Because this effect of out-migration
logically depends on the existence and
extent of in-migration, an interaction is
implied. Consistent with this, out-migration
has more of an effect on pricing, the
greater is in-migration.
4. Consistent with increasing switching costs
over time, account types that should be
subject to greater switching costs exhibit
the biggest reduction in deposit rates
Literature: Theory
• One-period
• Two period
• Multi-period, where new customers are
entering the market, old customers are
leaving the market, and the firm cannot
distinguish between old “locked-in”
customers and new customers in its pricing.
Beggs and Klemperer (1992).
Literature: Empirical
• Sharpe (1997)
• Hannan, Kiser, Prager, and McAndrews
(2003)
Theoretical Model
Vt i  ( rst  rdt .i )[ xi  newt Zit ( rdt ,i , rdt , j ,.)]
V [ t ,t 1 ( xi  newt Z ( r , r ,.))]
i
t 1
t
i
t
d ,i
t
d, j
(1)
Vt i denotes discounted future profits at time t.
rst denotes the rate earned on securities at time t.
rdt ,i denotes bank i’s deposit rate at time t
newt
denotes the number of new customers entering the market at t.
Z it (.) denotes the share of new customers attracted to bank i.

denotes a discount factor
xi
denotes the number of bank I’s locked-in customers at t
 t ,t 1 denotes the proportion of market depositors that “survive” to t+1
Theoretical Model
As an empirical matter, I measure the
“survival rate” as:
 t ,t 1  1  (outt 1 / popt )
Differentiation of (1) with respect to the
bank i‘ s deposit rate, division by popt ,
and making this substitution yields:
Theoretical Model
xi
newt
Z
Z
t
t
t
t
t
i'


[  Z i ( rd ,i , rd , j ,.)  ( rs  rd ,i ) t   Vt 1 (.) t ]
popt popt
rd ,i
rd ,i
newt outt 1 i '
Z

Vt 1 (.) t  0
popt popt
rd ,i
--The higher the rate of market in-migration the higher the deposit rate.
--The higher the rate of market out-migration, the lower the deposit rate,
but only in interaction with the rate of in-migration.
--The greater the discount factor and security rate, the greater the
deposit rate.
--Size, as expressed by xi ?
Empirical Model
rdt ,i   0  1hhimt 1   2 ln(mktincmt 1 )   3inmigratemt 1
  4outmigratemt 1 (inmigratet 1 )   t  i   it
m
1  0
 3   4outmigratemt 1  0
4  0
3  0
It follows that:
Data
12,000 observations of banks observed
annually from 1989 to 2004.
For each bank and year, interest rates were
calculated from balance sheet and income
data for four different kinds of deposit account
: interest-bearing transaction accounts (itrate),
savings deposits (svrate), small time deposits
(smtrate), and large time deposits (lgtrate).
Data
Migration data constructed from year-to-year
changes in addresses, available on a county
basis, derived from the population of returns
from the IRS Master File.
In-migrants—address outside the county at
time t-1 and inside the county at t.
Out-migrants—address in the county at time t1 and address outside the county at t.
Data
Following previous studies, markets are
defined as metropolitan areas (in the case of
urban markets) or BLS labor market area (in
the case of rural markets).
All are coterminous with counties.
Table 2
Means of Deposit Rates and Migration Variables,by Year
itrate
svrate
smtrate
lgtrate
inmigrate
outmigrate
1989
.048
.055
.081
.077
.058
.064
1990
.049
.056
.079
.075
.060
.064
1991
.045
.051
.071
.065
.061
.058
1992
.031
.037
.053
.047
.061
.061
1993
.024
.029
.043
.038
.062
.060
1994
.023
.029
.042
.039
.062
.060
1995
.024
.032
.056
.054
.063
.061
1996
.023
.032
.056
.052
.061
.060
1997
.023
.033
.056
.054
.061
.062
1998
.023
.033
.056
.054
.060
.062
1999
.021
.032
.052
.050
.060
.063
2000
.023
.035
.057
.057
.060
.063
2001
.018
.028
.057
.055
.059
.063
2002
.011
.017
.040
.035
.059
.061
2003
.007
.011
.029
.028
.057
.058
2004
.006
.010
.025
.024
.057
.058
Table 3
Bank Deposit Rates, and the Extent of In-migration and Out-migration
in Local Banking Markets, 1989-2004, with Bank and Year Fixed Effects
Dependent Variables:
constant
itrate
.046
(38.28)
svrate
.057
(44.75)
smtrate
.080
(67.37)
lgtrate
.076
(41.18)
hhi
-.18E-6**
(-2.62)
-.19E-6**
(-2.68)
-.84E-7
(-1.20)
-.20E-6+
(-1.68)
urban
-.48E-3
(-.93)
.0033**
(6.13)
ln(mktincome)
.11E-3
(1.29)
inmigrate
.0017**
(3.29)
.0022*
(2.62)
-.0024*
(-2.50)
-.18E-4
(-.20)
-.76E-4
(-.55)
.023**
(7.11)
.020**
(5.70)
.017**
(5.01)
.030**
(4.92)
.
.
-.027**
(-237.49)
.
-.039**
(-395.02)
.
-.043**
(-464.03)
.
.
-.022**
(-176.23)
.
-.039**
(-362.15)
.
-.046**
(-455.45)
.
.
-.025**
(-249.73)
.
-.044**
(-406.32)
.
-.052**
(-498.49)
.
.
-.021**
(-95.46)
.
-.042**
(-197.01)
.
-.054**
(-252.61)
outmigrate x inmigrate
.
.
year 2000
.
year 2002
.
year 2004
R2-within
Number of observations
Number of banks
.87
134,961
12,771
.87
134,961
12,771
.90
134,961
12,771
.70
134,961
12,771
Note: t-statistics are presented in parentheses. The symbols +, *, and ** denote significance at the 10, 5, and an 1 percent levels,
respectively. For purposes of space, coefficients of only three of the year binary variables are presented (coefficients relative to 1989).
Table 3a
Bank Deposit Rates, and the Extent of In-migration and Out-migration
in Local Banking Markets, 1989-2004, with Bank and Year Fixed Effects
Dependent Variables:
constant
itrate
.047
(36.81)
svrate
.058
(43.09)
smtrate
.079
(62.37)
lgtrate
.076
(38.78)
hhi
-.20E-6**
(-2.83)
-.20E-6*
(-2.64)
-.13E-6
(-1.64)
-.27E-6*
(-2.14)
-.43E-3
(-.79)
.0033**
(6.04)
.0015**
(2.92)
.0022**
(2.48)
.44E-4
(.48)
-.36E-3**
(-3.66)
-.92E-4
(-.98)
-.11E-3
(-.75)
urban
ln(mktincome)
inmigrate
outmigrate x inmigrate
.
.
year 2000
.
year 2002
.
year 2004
R2-within
Number of observations
Number of banks
.047**
(9.49)
.055**
(10.20)
.068**
(11.55)
.060**
(6.58)
-.18**
(-4.90)
.
.
-.27**
(-238.04)
.
-.039**
(-393.00)
.
-.043**
(-455.94)
-.29**
(-7.20)
.
.
-.022**
(-176.33)
.
-.039**
(-359.07)
.
-.046**
(-446.23)
-.43**
(-8.82)
.
.
-.025**
(-250.15)
.
-.044**
(-404.36)
.
-.057**
(-539.71)
-.23*
(-3.59)
.
.
-.021**
(-95.15)
.
-.042**
(-195.66)
.
-.054**
(-249.24)
.87
128,409
12,650
.86
128,409
12,650
.89
128,409
12,650
.69
128,409
12,650
Note: t-statistics are presented in parentheses. The symbols +, *, and ** denote significance at the 10, 5, and an 1 percent levels,
respectively. For purposes of space, coefficients of only three of the year binary variables are presented (coefficients relative to 1989).
Dependent Variables:
itrate
itrate
constant
.042
(26.59)
.047
(36.88)
hhi
-.23E-6**
(-3.18)
-.16E-6*
(-2.09)
-.19E-6**
(-2.63)
urban
-.31E-3
(-.58)
-.57E-3
(-1.06)
-.63E-3
(-1.14)
ln(mktincome)
-.83E-4
(-.88)
.47E-4
(.51)
.55E-4
(.60)
inmigrate
.049**
(9.86)
.047**
(9.51)
.026**
(4.92)
outmigrate x inmigrate
ln(bkassets)
-.49**
(-4.97)
-.19**
(-4.93)
.0044
(3.34)
-.15**
(-4.19)
.61E-3**
(6.22)
.
branchshare
.
-.0012+
(-1.69)
svrate
svrate
.058
(35.87)
.058
(43.11)
.012
(8.51)
-.20E-6**
(-2.60)
-.17E-6*
(-2.10)
-.17E-6**
(-2.28)
-.0033**
(6.01)
.0032**
(5.75)
.0030**
(5.37)
-.34E-3**
(-3.45)
-.35E-3**
(-3.64)
-.32E-3**
(-3.31)
.055**
(10.15)
.056**
(10.22)
-.29**
(-7.19)
-.29**
(-7.22)
.
.
.016**
(6.70)
.87
128,408
12,649
svrate
.040**
(6.89)
-.26**
(-6.68)
-.71E-4
(-.65)
.
popgrowth
R2-within
Number of observations
Number of banks
itrate
.87
128,408
12,649771
.86
118,852
12,262
.
.87
128,408
12,649
.
-.78E-3
(-1.06)
.
.86
128,408
12,649
.
.
.057*
(2.25)
.85
118,852
12,262
Conclusion
Consistent with the importance of switching
costs:
1. Deposit rates are higher in markets with
greater in-migration
2. Deposit rates a lower in markets with
greater out-migration
3. The effects of in-migration and outmigration interact such that out-migration
has a bigger effect, the greater is inmigration (and in-migration has a smaller
effect, the greater in out-migration)
Conclusion
4. Consistent with increasing switching costs
over time, the deposit rate of the account type
that should be most subject to switching costs
(interest bearing transaction accounts) tended
to decline by more than the rates offered on
other account (Speculative).
--