The government recently repealed Regulation Q, set to go in effect July 21, 2011. This means that small business owners will be able to earn interest on DDA accounts, which has various implications for relationships with community banks and the cost of banking.
Regulation Q, passed by Congress in the 1930s, prohibited banks from paying interest on demand deposit accounts which are held by many businesses and individuals. The goal of the law was to reduce bank competition for deposits and stabilize the banking industry in light of the Great Depression. DDAs are flexible in the sense that they have no maturity period, eligibility requirements, or minimum number of withdrawals or transfers. Usually there is no notification for withdrawal and the money is payable on demand—if one is required it must be less than seven days.
The last change to Regulation Q, which occurred in the 1980s, had the goal of discouraging account holders from moving their money from normal and interest-bearing accounts. The repeal of the law will mean that business owners save time once used moving their money around in order to earn hard interest. It will also mean that big banks such as Capital One will be making more of an effort to court owners for business.
Capital One’s new type of account is called the Clear Interest Business checking account and offers a special interest rate for the first 12 months and a market-competitive rate afterwards. Other added perks are no monthly fees for deposits over $10,000 and 300 free transactions per month. They have also hired business specialists that will help to establish and manage their new accounts. Other big banks such as Deutsche are rumored to be rolling out similar programs in the near future.
According to AllBusiness.com, banks have three options in light of the repeal. The first is to pay hard interest on the average account balance and to get rid of the earned credit rate (ECR), meaning that banks will charge customers for services directly. The second option is to offer credit to the part of the average balance required to pay service fees and interest on the remaining amount. And, the last option is to not pay any interest, although this could result in a significant loss of business.
One drawback of an interest-bearing account is that it is not covered under the unlimited FDIC insurance policy, set to expire on December 31, 2012. Having FDIC coverage with an interest-bearing account will be an added expense that will be passed on to customers through higher loan rates, transaction fees, and adjustments to rate structure. Interest-bearing accounts are also taxable, which will take away some of the hard dollars paid by banks.
For community banks, the repeal of the regulation is a significant loss since small businesses are expected to shift to work with large banks that will offer better rates. While increased competition among banks will benefit small business owners in the sense of being able to get more competitive rates, it can be dangerous in the sense of creating a volatile atmosphere characterized by artificial inflation. Business owners will be incentivized to move their money around, which then could lead to problems in regards to liquidity and meeting stable funding requirements. Previous soft incentives such as earning credits placed towards services may not be enough to keep business owners at one bank.
Another change that can be expected as a result of the repeal is the way that account analysis statements are handled. Currently, account analysis software allows business owners to calculate and compare account fees within a single bank and among different banks. With this information, they can compare earnings and negotiate with contacts at banks for cheaper rates. With the repeal of Regulation Q, the earnings from interest rates must be factored into these calculations in addition to tax considerations, effecting owners’ decisions about how much money to keep in each account, etc.
The repeal of Regulation Q offers an excellent opportunity for small business owners to grow their funds with less effort than was required previously. As larger banks such as Capital One will likely be the first to implement special checking accounts, owners’ relationships with community banks are predicted to weaken. Nonetheless, it is important that owners pay attention to the climb in fees which are expected to result from banks losses in net interest income margins from increased competition for customers. When making a decision about which type of account to choose, think about your businesses’ cash flow requirements. Do you need the cash or would it be better to accept soft earning credits, which will decrease banking fees and exempt you from taxes? Lastly, keep track of the various expenses associated with accounts held with a single or multiple banks. This will allow you to decide the best place to keep your funds taking into consideration fees, taxes and interest rates.
1) Independent Community Bankers of America: “Prohibition Against Payment of Interest on Demand Deposits”
2) Federal Reserve: “Regulations Q and D: Interest on Demand Deposits/Reserve Requirements”
3) Bloomberg Businessweek: “What Regulation Q’s Repeal Means for Business Checking”
4) Association for Financial Professionals: “Reg Q Reactions: What Every Corporate Should Know”
5) Banking on Analytics: “Are you ready for the demise of Regulation Q?”