Risk Management of Demand Deposits in a Low Interest Rate Environment

In this paper, we focus on the liquidity characteristics (stability and maturity) of retail deposits in the Czech Republic and changes in the structure of retail deposit products that occurred because of low interest-rate environment. Retail deposits are a primary source of funding for banks in the Czech Republic. In simplicity, we divide retail deposits into two main groups: (i) demand deposits are products with non-maturing features as maturity (timing of cash flows) is not known by a bank as a client can withdraw a deposit on notice while in reality deposits remain in a bank for a longer period; (ii) term deposits are products with maturing characteristics, i.e. a timing of cash flows is known. Bankers deem retail deposits as a largely stable and cheap funding source. Our research shows that demand deposits are a stable funding source with much higher maturity than term deposits. Moreover, we conclude that the transfer of term deposits to demand deposits that accelerated in recent years resulted from a low interest rate environment. This transfer implies increasing liquidity risk of the Czech banking sector. However, we argue that banks should be able to hedge this risk properly.