Regulation D Reserve and Earnings Credit

Issue/Inquiry

The Bank is looking to update its products that have account analysis features offset by an earnings credit. The earnings credit is calculated on the customer’s average available balance for the month minus a reserve requirement of 10 percent. This gives the Bank a net average available balance which is used to calculate the credit. Are there any regulatory requirements associated with this reserve amount?

Response Summary

The reserve requirement assessed by the Bank is most likely related to the reserve for net transaction account balances required by Regulation D. However, effective March 26, 2020, the Federal Reserve Board reduced the reserve required for net transaction account balances to zero percent.

Response Detail

The earnings credit came into use during the Great Depression, when Regulation Q was implemented. Regulation Q was intended to prevent banks from offering interest on commercial demand deposit accounts so that the money, instead of being deposited, would be used to invest in interest-earning or value-appreciating vehicles. To prevent the outflow of balances, the banks began offering earnings credit, which could be applied to the fees assessed for the commercial demand deposit accounts.

As discussed below, Regulation D required banks to keep a reserve for the transaction accounts that they have. Since the reserve balance necessary to satisfy the reserve requirement was non-earning, there was a practice of deducting this reserve from balances that received an earnings credit. However, this was simply a practice and not a regulatory requirement.

The prohibition of Regulation Q regarding paying interest on commercial demand deposit accounts was abolished by the Dodd-Frank Act in 2011. Nevertheless, many banks still offer an earnings credit. Where a reserve was required for such a credit, some banks would describe it as the Regulation D reserve requirement.

With respect to the reserve requirement, the Federal Reserve Act authorizes the Federal Reserve Board to establish such requirements for the purpose of implementing a monetary policy on certain types of deposits and other liabilities of depository institutions.The dollar amount of a depository institution’s reserve requirement is determined by applying the reserve requirement ratios specified in the Federal Reserve Board ‘s Regulation D (Reserve Requirements of Depository Institutions, 12 CFR Part 204) to an institution’s reservable liabilities.

Reserve requirement ratios on net transaction accounts differ, based on the amount of net transaction accounts at the depository institution. A “transaction account” is a deposit or account from which the depositor or accountholder is permitted to make transfers or withdrawals by negotiable or transferable instrument, payment order of withdrawal, telephone transfer, or other similar device for the purpose of making payments or transfers to third persons or others or from which the depositor may make third party payments at an automated teller machine (ATM) or a remote service unit, or other electronic device, including by debit card. 12 CFR 204.2(e).

Transaction accounts have the following characteristics:

• Limited to demand, NOW, and Automatic Transfer Service (“ATS”) accounts
• Permit a depositor to make unlimited transfers to third parties
• Permit a depositor to make unlimited transfers between accounts of the same depositor at the same in the same institution. FDIC, Consumer Compliance Examination Manual, Regulation D.

Time and savings accounts are excluded from the definition of “transaction accounts”.

A certain amount of net transaction accounts, known as the “reserve requirement exemption amount”, was subject to a reserve requirement ratio of zero percent.  Net transaction account balances above the reserve requirement exemption amount and up to a specified amount, known as the “low reserve tranche”, were subject to a reserve requirement ratio of 3 percent.  Net transaction account balances above the low reserve tranche were subject to a reserve requirement ratio of 10 percent. The reserve requirement exemption amount and the low reserve tranche were indexed each year pursuant to formulas specified in the Federal Reserve Act.

Prior to March 26, 2020, the reserve requirement exemption was $16.9 million and the low reserve tranche was $125.7 million. This meant that a zero percent reserve was required for net transaction account balances up to $16.9 million, a three percent reserve was required for net transaction account balances over $16.9 million up to $125.7 million, and a 10 percent reserve was required for net transaction account balances over $125.7 million.

As announced on March 15, 2020, the Federal Reserve has reduced the reserve requirement for net transaction account balances to zero percent, effective March 26, 2020. Federal Reserve Board, Policy Tools, Reserve Requirements, March 20, 2020.

Regardless of the amount of transaction account balances a bank may have, no reserve is required for them.

This means that there is no longer a need for the Bank to reserve any portion of the earnings credit to cover the reserve requirement of Regulation D. Whether the Bank wants to have a reserve requirement for its earnings credit for any other reason, or whether it wants to offer an earnings credit at all, is a business decision for it to make.

This response is for informational purposes only and is not intended for legal guidance.

This entry was posted on Monday, March 30th, 2020 at 9:37 am.