On Thursday, April 14, 2011, the Board of Governors of the Federal Reserve System (the “Board”) issued proposed rules and a request for public comment in connection with the repeal of its Regulation Q (Interest on Deposits). The proposed rule also sets forth conforming changes to the Board’s Regulation D (Reserves on Deposits) and Regulation DD (Truth In Savings).
Regulation Q was promulgated in 1933 to implement Section 19(i) of the Federal Reserve Act. Until financial deregulation occurred in the early 1980s, Regulation Q, in addition to prohibiting the payment of interest on demand deposits, limited the amount of interest that could be paid on various interest-bearing deposits. Since then, the regulation has only prohibited the payment of interest on demand deposits. Section 627 of the Dodd-Frank Wall Street Reform and Consumer Protection Act repeals Section 19(i) of the Federal Reserve Act, effective July 21, 2011. Accordingly, Regulation Q will be repealed as of that date.
The repeal of the prohibition of interest on demand deposits will permit a product line that depository institutions have been trying to implement for decades – an interest-bearing transaction account for businesses. Generally, a “transaction account” permits unlimited withdrawals without notice to the institution, the best example being a traditional checking account. Consumers have been able to establish interest-bearing transaction accounts since the 1970s, when Congress created a statutory exception to the general prohibition, known as Negotiable Order of Withdrawal accounts, or NOW accounts. Throughout the last several decades, depository institutions have attempted various “work-around” products such as sweep accounts combined with non-deposit products such as commercial repurchase agreements, in order to offer a product with the practical effect of an interest-bearing transaction account for their commercial customers. These were implemented with varying degrees of success. The proposed repeal should obviate the need for such devices.
The Board is seeking comment on the entire proposal, but specifically on the following issues (as set forth in the notice of proposed rulemaking):
- Does the repeal of Regulation Q have significant implications for the balance sheets and income of depository institutions? What are the anticipated effects on bank profits, on the allocation of deposit liabilities among product offerings, and on the rates offered and fees assessed on demand deposits, sweep accounts, and compensating balance arrangements?
- Does the repeal of Regulation Q have any implications for short-term funding markets such as the overnight federal funds market and Eurodollar markets, or for institutions such as institution-only money market mutual funds that are active investors in short-term funding markets?
- Is the repeal of Regulation Q likely to result in strong demand for interest-bearing demand deposits?
- Does the repeal of Regulation Q have any implications for competitive burden on smaller depository institutions?
We spoke with a senior staff attorney at the Board, who indicated that comments have been predictably mixed on the repeal, from larger institutions welcoming the repeal, to smaller institutions complaining that “our margins are small enough as they are.”
Depository institutions may comment, and should do so if they think that the repeal, or the specifics of the implementation of the repeal as published in the notice, will have an adverse effect on their businesses. According to the notice of proposed rulemaking, comment letters should refer to Docket No. R-1413 and RIN No. 7100-AD70 and, when possible, should use a standard typeface with a font size of 10 or 12. Comments may be mailed electronically to email@example.com.