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Week Ending May 27, 2005
HR 1224 to repeal the prohibition on the payment of interest on demand deposits, and for other purposes.
BRIEF
The core element of the bill would allow banks to pay interest on business accounts known as demand deposit accounts. Individual and business checking accounts are typical of demand deposit accounts in that they must be given to the customer “on demand.”
Most banks have some variations on demand deposit accounts paying varying interest rates for accounts with varying “minimum account balances”. Such accounts may also limit the amount of times money can be withdrawn or transferred from the account.
The bill would allow banks to pay interest on demand accounts for business customers and allow up to 24 transfers per month (currently six transfers are allowed) if it is to an account owned by the same customer and it is in the same bank.
The rules would apply to credit unions and similar depository institutions but would not apply to what are called industrial banks or industrial loan companies-institutions that are owned by a commercial entity. (An entity that derives more than 15 percent of revenue from non-banking activities.)
Under the bill, should the Federal Reserve Bank (Fed) decide so, banks would no longer be required to maintain a reserve at the Fed to cover transaction accounts. The Fed, however, would be required to pay to member banks interest on all reserve accounts held at the Fed and to do so at least quarterly.
It should be noted that the Federal Reserve Bank makes money by investing its’ holdings in Treasury securities and gaining an interest income. The Fed also makes money from the Treasury on interest paid to the Fed by Treasury on the Treasury’s own reserve funds. All that profit is considered government receipts and is deposited in the US Treasury.
If this bill becomes law and the Fed begins paying interest on reserve funds the Fed interest paid will be considered a loss to the Fed and, since the money the Fed earns is considered government receipts, a loss to the Treasury and to the taxpayers as well.
So, how will the bill deal with the loss to the taxpayer? It looks like something of a guess based on human inclination.
According to the Congressional Budget Office one likely prospect is that banks, seeing profit on interest paid by the Fed on their reserves would persuade business depositors to move their funds to demand deposit accounts requiring the banks to increase their reserves at the Fed and get paid more in interest. Since the bill allows the Fed to control the amount of reserve funds, down to zero if it wants, the fed can avoid paying interest by lowering or eliminating the amount of reserve money the banks must keep in reserve at the Fed. On the other hand increased reserves would allow the fed to invest more of that money in interest bearing Treasury Securities, increase its’ profits from interest on those securities and so increase government receipts.
This juggling game would be expected to come to a profitable fruition because the loss to the Fed would be seen as a loss of tax revenue but similar to reducing business taxes in general. The predicted outcome is that the money is in motion. Reserve funds produce increased revenue for the banks and increased reserve funds increase interest revenue for the Fed. All of this newly found profit would find its’ way to the wage earner as higher income leading to higher payroll taxes and more money released into the economy. The Committee report indicated that, in the long run, there is a revenue loss to the taxpayer but it won’t kick in until 2010.
Finally, the bill would require a report of fairly intense scrutiny on how banks do business in regard to deposits and transactions. The Board of Governors of the Fed would produce an annual report on most types of transactions including ATM transactions that includes monthly and annual fees, minimum opening balances, check processing fees, check printing fees, balance inquiry fees, fees imposed for using a teller or other institution employee, stop payment order fees, non-sufficient fund fees, overdraft fees, fees imposed in connection with bounced-check protection and overdraft protection programs, deposit items returned fees, availability of no-cost or low-cost accounts for consumers who maintain low balances as well as equally detailed information on ATM transactions and savings accounts.
Sponsor: Representative Sue W. Kelly (R-NY-19th)
Vote: Passed House by voice vote (May 23, 2005)
Cost to the taxpayers: $1.8 billion 2010 through 2015.
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MORE INFORMATION
SECTION BY SECTION ANALYSIS (FROM THE COMMITTEE REPORT)
PURPOSE AND BILL BACKGROUND
H.R. 1224, the Business Checking Freedom Act of 2005, repeals the prohibition on the payment of interest on commercial demand deposits, increases the number of inter-account transfers which may be made from business accounts at depository institutions, and authorizes the Board of Governors of the Federal Reserve System to pay interest on reserves.
The legislation removes the prohibition on the payment of interest on commercial demand deposit accounts after a two year period, and authorizes the payment of interest on most negotiable order of withdrawal (NOW) accounts maintained by businesses, with the exception of business accounts maintained at industrial loan companies (ILCs) owned by corporate parents that derive more than 15 percent of their gross revenues from activities that are not financial in nature or incidental to such activities and whose applications for deposit insurance were approved after September 30, 2003. The bill also authorizes the Federal Reserve to pay interest on the reserves that depository institutions maintain at Federal Reserve Banks, and eliminates the minimum statutory ratios that currently apply to those reserves, thereby giving the Board of Governors of the Federal Reserve greater flexibility in setting reserve requirements. To offset the revenue loss associated with allowing interest payments on reserve balances, the legislation requires that the Federal Reserve remit from its surplus fund to the Treasury an amount equal to the estimated annual revenue loss during the first five years the legislation is in effect. The legislation increases the number of allowable transfers from interest bearing or dividend earning commercial deposits or accounts to 24 per month, from the current limit of six, enabling depository institutions to sweep funds between non-interest bearing commercial checking accounts and interest bearing accounts on a daily basis with the exception of the heretofore referenced ILCs. Finally, the legislation directs the Board of Governors of the Federal Reserve System to conduct an annual survey of retail bank fees and services.
Under current law, depository institutions may not pay interest on demand deposit accounts. Because of the widespread availability of NOW accounts for non-business account holders, business account holders are the only depositors effectively barred from earning interest on their checking accounts. This disparity creates an incentive for banks to circumvent this restriction by using methods to offer their business customers accounts that are roughly equivalent to interest-bearing checking accounts, but at significant cost to the customer. Because of the costs associated with these programs, small businesses are particularly disadvantaged in attempting to earn some return on the money they hold in checking accounts.
Additionally, under the Federal Reserve Act, banks, thrifts, and credit unions are required to hold funds against transaction accounts held by customers of those institutions. These funds must be held either in cash or on reserve at Federal Reserve Banks. Current law does not authorize Federal Reserve Banks to pay interest on reserve balances. Because of this limitation, these funds have come to be known as `sterile reserves' and financial institutions have sought ways to minimize their reserve requirements. Consequently, reserve balances at Federal Reserve Banks have declined dramatically in recent years, falling from approximately $28 billion in 1993 to approximately $10 to $12 billion today.
According to the Federal Reserve, the decline in reserves has potential consequences for its ability to conduct monetary policy. Reserve requirements play an important role in open market operations aimed at influencing general monetary and credit conditions by varying the cost and availability of reserves to the banking system. Declines in reserves could lead to increased volatility in the Federal funds rate, and, if it became a persistent feature of the money market, would affect other overnight interest rates, raising funding risks for large banks, securities dealers, and other market participants. Small banks and thrifts, as well as other sources of funds for overnight markets, would face increased uncertainty about their rates of return.
CBO REPORT
Summary: H.R. 1224, the Business Checking Freedom Act of 2005, would allow depository institutions to pay interest on business demand deposit accounts. H.R. 1224 also would allow the Federal Reserve System to pay interest on any reserve balances held on deposit at the Federal Reserve by insured depository institutions, except nonqualified industrial loan companies. The Board of Governors of the Federal Reserve Board (FRB) would have greater flexibility in setting reserve requirements and would be required to submit an annual report to the Congress summarizing many of the services provided and fees charged to consumers by depository institutions. The reduction in revenues as a result of the interest payments on reserves would be offset through 2009 by transfers from surplus funds of Federal Reserve Banks to the U.S. Treasury.
CBO estimates that the bill would have no net effect on annual revenues over the 2006-2009 period because the estimated loss in revenues would be offset by transfers from Federal Reserve surplus funds. Enacting H.R. 1224 would decrease revenues after 2009. CBO estimates that the loss in revenues would total approximately $1.8 billion over the 2010-2015 period.
CBO estimates that H.R. 1224 would have no significant effect on federal spending. It contains no intergovernmental or private-sector mandates as defined in the Unfunded Mandates Reform Act (UMRA) and would impose no costs on state, local, or tribal governments.
Estimated cost to the Federal Government: The estimated budgetary impact of H.R. 1224 is shown in the following table.
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By fiscal year, in millions of dollars--
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
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CHANGES IN REVENUES
Allowing Interest on Reserves 0 -181 -108 -135 -154 -174 -195 -204 -213 -224 -235
Transfers of Federal Reserve Bank Surpluses to the Treasury 0 181 108 135 154 -578 0 0 0 0 0
Net Budgetary Effect 0 0 0 0 0 -752 -195 -204 -213 -224 -235
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The initial budgetary effect of H.R. 1224 would be a decrease in the payment of profits from the Federal Reserve System to the U.S. Treasury. The Federal Reserve remits its profits to the Treasury, and those payments are classified as governmental receipts, or revenues, in the federal budget. Any additional income or costs to the Federal Reserve, therefore, can affect the federal budget. The Federal Reserve's largest source of income is interest from its holdings of Treasury securities. In effect, the Federal Reserve invests in Treasury securities the reserve balances and issues of currency that constitute the bulk of its liabilities. Since the Federal Reserve pays no interest on reserves or currency, and the Treasury pays the Federal Reserve interest on its security holdings, the Federal Reserve earns profits.
By allowing the Federal Reserve to pay interest on reserves, the bill would decrease the Federal Reserve's profits and thereby reduce federal revenues by an estimated $578 million over the 2006-2009 period. This budgetary response has several significant components. First, the Federal Reserve's payment of interest on required reserve balances held at Federal Reserve banks would tend to reduce governmental receipts. CBO anticipates that some depository institutions and depositors would respond to the interest payments on reserves (and interest payments on business demand deposit accounts) by shifting funds out of consumer `retail' and business `wholesale' sweep accounts and into demand deposit accounts. This secondary response would increase required reserve balances, although the Federal Reserve would be expected to offset a portion of it by lowering reserve requirements. The net increase in reserves would partially offset the loss in federal revenues from the payment of interest on reserves. Finally, those net reductions in Federal Reserve receipts would act like reductions in indirect business taxes, generating increases in other incomes in the economy and subsequently higher income and payroll taxes. Those higher income and payroll taxes would offset the declines in Federal Reserve receipts by an estimated 25 percent, roughly the marginal tax rate on overall incomes in the economy. The legislation also stipulates that the overall revenue loss would be offset by a transfer from surplus funds of Federal Reserve banks to the U.S. Treasury for each fiscal year through 2009. Revenue losses would therefore commence in 2010.
Basis of Estimate: The estimates are based on the assumption that the provisions would become effective early in fiscal year 2006.
H.R. 1224 would permit the Federal Reserve to pay interest on balances held on deposit at the Federal Reserve. Depository institutions hold three types of balances at the Federal Reserve-required reserve balances, contractual clearing balances, and excess reserve balances. Required reserve balances are the balances that a depository institution must hold to meet reserve requirements. Depository institutions may also hold additional balances called required or contractual clearing balances, which can earn an implicit rate of interest in the form of an interest credit that is used to defray fees for Federal Reserve services. Contractual clearing balances have risen over the last decade from under $2 billion in 1990 to roughly $9 billion today. Excess reserves are funds held at reserve banks in excess of a depository institution's required reserve and contractual clearing balances. Staff at the Federal Reserve has indicated that, given the authority, the Federal Reserve would pay interest on required reserve balances and give depository institutions the option of earning an explicit rate of interest on contractual clearing balances or continuing with the current system of earning an interest credit. (The payment of interest on required reserve balances and the payment of interest on contractual clearing balances are discussed separately in this estimate, since their effects on revenues are likely to be different.) We believe that the Federal Reserve would choose not to pay interest on excess reserve balances, unless required reserve balances fell to such a low level that interest on excess reserves was needed to build reserves. That is considered to be an unlikely scenario.
Interest on Required Reserve Balances. The budgetary effect of interest on required reserve balances is divided into three components. First, the bill would result in the Federal Reserve paying interest on the required reserve balances expected under current law, reducing its net income and, therefore, governmental receipts. Second, the payment of interest on reserves would cause demand deposit balances at depository institutions to increase. That increase would raise the level of reserve balances held at the Federal Reserve, although the increase would likely be diminished by Federal Reserve actions to reduce reserve requirements. The higher reserve balances at the Federal Reserve would increase its earnings because it would invest the balances at a higher rate than it would pay on them. This change in projected reserves would increase governmental receipts, but would only partially offset the loss caused by the payment of interest on reserves projected under current law. Third, the net reduction in Federal Reserve receipts from the first two effects would be partially offset by increased income and payroll tax receipts.
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Allowing interest on reserve balances (by fiscal year, in millions of dollars)
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
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CHANGES IN REVENUES
Revenue from Federal Reserve:
Interest on Required Reserves 0 -314 -232 -256 -268 -281 -294 -308 -322 -338 -355
Profits from Increased Reserves 0 73 88 76 63 50 34 36 37 39 41
Net Effect on Revenue from Federal Reserve 0 -242 -144 -180 -205 -232 -260 -272 -284 -299 -314
Income and Payroll Tax Offsets 0 60 36 45 51 58 65 68 71 75 78
Net Effect of Allowing Interest on Reserves 0 -181 -108 -135 -154 -174 -195 -204 -213 -224 -235
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Interest Payments on Required Reserves Projected Under Current Law. Because depository institutions currently do not earn a return on required reserve balances, they have an incentive to minimize such balances. Required reserve balances measured almost $30 billion at the end of 1993, but generally have ranged between $12 billion and $14 billion in the past year and were about $5 billion in early 2000. The expansion of consumer and business sweep accounts has caused this general decline. In typical sweep accounts, banks shift their depositors' funds from demand deposits, against which reserves are required, into other depository accounts, against which reserves are not required. The banks shift the funds back to the demand deposit accounts the next business day, or when needed by the depositor. Sweep accounts for business demand deposits have existed in various forms since the early 1970s. Advances in computer technology in the 1990s made the shifting of funds feasible for many consumer accounts as well. Under current law, CBO expects the expansion of retail and business sweep accounts to continue, in part because of the effects of rising interest rates. CBO expects required reserve balances to decline to about $5 billion over the next two years and to rise gradually in subsequent years, with growth in the economy.
Under H.R. 1224, the Federal Reserve would be allowed to choose the interest rate it pays on reserve balances, although the rate chosen could not exceed the general level of short-term interest rates. Staff at the Federal Reserve has indicated that the Federal Reserve would choose an interest rate near the key short-term rate, the federal funds rate. The likely rate would be 10 to 15 basis points lower than the federal funds rate to account for the lack of risk. Accordingly, CBO assumes that the Federal Reserve would pay interest only on required reserves at a rate of 10 to 15 basis points below the federal funds rate.
CBO projects that the federal funds rate will average about 4 percent in 2006 and 4.9 percent over the 10-year period from 2006 through 2015. The payment of interest on reserves is assumed to start early in fiscal year 2006. CBO projects that H.R. 1224 would cause the Federal Reserve to pay interest to depository institutions of about $314 million in 2006 on $8 billion of required reserve balances expected under current law. For several years thereafter, the interest paid to depository institutions would be lower because required reserves under current law would decline as a result of higher interest rates. Over the 2006-2010 period, such interest payments would total about $1.4 billion. Those payments would reduce the profits of the Federal Reserve--and thus its payments to the Treasury--by the same amount.
Projected Impact of the Bill on the Volume of Reserves. If the Federal Reserve pays interest on required reserve balances, there would be a second budgetary effect on the Federal Reserve that would reduce, but not eliminate, the net revenue loss from the payment of interest. In particular, based on a survey by the FRB, we would expect reserve balances to increase because depository institutions would close a significant share of their retail and business sweep accounts and, as a result, maintain a higher level of required reserves. The payment of interest on business demand deposit accounts coupled with the payment of interest on reserves would give both businesses and depository institutions an incentive to open business checking accounts and close wholesale sweep accounts. Under current law, depository institutions are already allowed to pay interest on consumer demand deposits. By closing a significant share of consumer and business sweep accounts, depository institutions could eliminate the costs of maintaining the sweep accounts and receive a return on their required reserves, although presumably at a lower rate than what they could receive if they invested the funds in other ways.
CBO assumes that depository institutions would eliminate approximately 30 percent of both retail and business sweep accounts currently in existence by 2008 and half of those that otherwise would be established. Although the payment of interest on business demand deposits by depository institutions would not be permitted until two years after enactment of H.R. 1224, the bill would allow businesses to establish interest-bearing transaction accounts. Businesses would be allowed up to 24 transfers per month (or more if the Federal Reserve permits) into a demand deposit account that would be subject to reserve requirements. Because reserve requirements would also apply to those accounts, they would be similar to interest-bearing demand deposits. As a result of the closings of retail and business sweep accounts, demand deposits for which reserves are required would increase at depository institutions.
The increase in reserves from the closing of many sweep accounts would likely provide the Federal Reserve with more reserves than needed for implementing monetary policy. H.R. 1224 would relax the current lower bound on reserve requirements, therefore providing the Federal Reserve with the option of lowering reserve requirements, perhaps substantially, in the face of increasing reserves. The Federal Reserve has indicated that it would study the possible strategies for setting reserve requirements in such an environment.
Under current law, the Federal Reserve can set reserve requirements as high as 14 percent and as low as 8 percent of transactions deposits (above a fixed threshold). The Federal Reserve has kept the requirement at 10 percent for most transactions deposits since 1992. H.R. 1224 would remove the lower limit of 8 percent.
CBO assumes the Federal Reserve would offset a part of the increase in reserve balances by lowering reserve requirements. The magnitude and timing of such changes is very uncertain, but CBO assumes that required reserves would be maintained at roughly $10 billion to $15 billion, which is consistent with the balances in recent years. Reductions in reserve requirements would begin in 2008.
As a result, CBO projects that required reserve balances would increase above the level expected under current law and generate additional net income to the Federal Reserve. Although the Federal Reserve would pay interest on the added reserves at approximately the federal funds rate, it would invest the reserves in Treasury securities, earning a rate of return approximately 0.6 of a percentage point in excess of that which it pays. As a result of that differential, the Federal Reserve would generate additional profits of about $73 million in 2006 and $349 million over the 2006-2010 period.
Projected Offsetting Impact on Tax Revenues. Allowing interest on required reserve balances held at the Federal Reserve would have a third budgetary effect that would also partially offset the decline in revenue from the payment of interest on current balances. The current reserve requirement on depository institutions, without provision of interest, is like an indirect business tax. Allowing interest payments on reserves, therefore, would generate the same economic effects as does removing an excise tax. Assuming that GDP remains unchanged, reductions in excise tax receipts generate equal increases in other incomes in the economy. The higher incomes produce increases in income and payroll taxes that offset an estimated 25 percent of the reduction in excise tax receipts, roughly the marginal tax rate on overall incomes in the economy. In this case, a quarter of the loss in receipts from the Federal Reserve would be offset by an increase in income and payroll tax receipts. CBO estimates that the loss in Federal Reserve receipts would total $242 million in 2006, offset partially by an increase in income and payroll taxes of $60 million. Over the 2006-2010 period, the loss in Federal Reserve receipts would total about $1 billion and the increase in income and payroll taxes would total about $250 million.
The Allowance of Interest on Contractual Clearing Balances. Staff at the Federal Reserve have indicated that, given the authority, the Federal Reserve would give depository institutions the option of earning an explicit interest payment on contractual clearing balances or continuing with the current system of earning an implicit interest payment in the form of an interest credit, which can be used to offset fees for services provided by the Federal Reserve. CBO estimates that giving depository institutions the option of earning an explicit rate of interest on contractual clearing balances would have little or no budgetary effect.
For those depository institutions choosing an explicit interest payment on contractual balances, the explicit interest earnings, for the most part, would be substituted for what is now an implicit interest payment. Earning an explicit rate of interest on contractual balances may give some depository institutions an incentive to hold somewhat higher balances than currently because the interest credit earned under the present system can only be used to offset user fees for services provided by the Federal Reserve. A number of banks are already able to cover all of their service costs this way, so that an explicit interest payment is required to give them an incentive to hold more balances.
The Federal Reserve would pay an interest rate based on and lower than the short-term Treasury bill rate, which is consistent with the calculation currently used for the implicit interest on contractual balances, and invest the funds in Treasury securities. The difference between what the Federal Reserve pays in interest on these additional balances and what it earns by investing them in Treasury securities would result in an increase in Federal Reserve earnings. Depository institutions, however, may choose to increase their contractual clearing balances by reducing the excess reserve balances they hold at the Federal Reserve. The Federal Reserve currently pays zero interest on excess reserves and invests them in Treasury securities, remitting these earnings to the Treasury. The additional earnings on contractual clearing balances could be completely offset, or possibly more than offset, depending on the extent to which depository institutions choose to increase their clearing balances by reducing their excess reserve balances. For example, if clearing balances increase by $2 billion and the rate differential between the interest rate applicable to clearing balances and Treasury securities is 1.0 percentage points, Federal Reserve earnings would increase by $20 million. If, however, $400 million of the increase in clearing balances was the result of a transfer from excess reserves by depository institutions, then, assuming a rate of return on Treasury securities of 5 percent, Federal Reserve earnings would not change because the $20 million increase in earnings would be offset by a decline of $20 million from the investment of excess reserves. CBO, therefore, estimates that making explicit interest payments on contractual clearing balances is likely to have little or no significant effect on earnings.
During the first four years that H.R. 1224 would be effective (fiscal years 2006 through 2009), the legislation provides that the revenue loss associated with allowing interest payments on reserve balances would be offset by requiring the Federal Reserve to remit from its surplus fund to the Treasury an amount equal to an estimate of the annual net revenue loss. In addition, during this same period, the bill would make the Federal Reserve payment of net earnings to the Treasury mandatory and the Federal Reserve would not be allowed to replenish its surplus fund. Those provisions would have the effect of reducing the cost of the legislation to zero through 2009 and postpone the accumulated net revenue loss to the federal government until 2010.
Out of its annual earnings, the Federal Reserve covers its operating costs, pays a small dividend to its member banks, retains monies for its surplus fund, and voluntarily remits the remaining profits to the U.S. Treasury. The Federal Reserve's surplus fund is a stock of retained earnings accumulated over time and is set by the Federal Reserve each year at a level equal to the paid-in capital of its member banks. The fund can be used as collateral for issuance of Federal Reserve notes and may be viewed as a fiscal cushion. The surplus funds are invested in Treasury securities and the interest generated is remitted to the Treasury along with other profits of the Federal Reserve.
During the period through 2009, H.R. 1224 would direct the Federal Reserve to remit to the Treasury all of its earnings above its member bank dividend payments, additions to its surplus account, and operating costs, which would now include interest paid on reserves. In addition, it would be required to remit from its surplus fund an amount equal to the estimated cost of paying interest on reserves. The Federal Reserve would be prevented from replenishing its surplus fund by the amount of these transfers through 2009 and its payment of net earnings to the Treasury would be mandatory. In fiscal year 2010, however, the Federal Reserve would be expected to replenish its surplus fund by the entire amount that was transferred from the fund to the Treasury during the 2006-2009 period, an estimated $578 million. This response is anticipated because the Federal Reserve has replenished its surplus account at its first available opportunity when transfers from the surplus fund have been mandated in the past. The legislated surplus fund transfer under H.R. 1224, therefore, would postpone until 2010 the accumulated net revenue loss to the Treasury during the period from 2006 to 2009. CBO estimates that the revenue loss in fiscal year 2010 would be about $752 million. The Federal Reserve would be expected to retain $578 million out of its earnings to replenish its surplus fund instead of remitting these profits to the Treasury. The remaining $174 million is the estimated net revenue loss from making interest payments on reserve balances for that year. CBO estimates that the resulting revenue loss for the 2010-2015 period would be about $1.8 billion.
The transfer of the surplus funds would not reduce the budgetary effect of the bill to the federal government over the long term; it would just postpone it. It also is important to note that the transfer of surplus funds from the Federal Reserve to the Treasury has no import for the fiscal status of the federal government. If the surplus funds are held at the Federal Reserve, they are invested in government securities and the interest generated is remitted to the Treasury. If the surplus funds are transferred to the Treasury instead, they reduce the public debt and in turn the interest payments owed by the Treasury. Since the interest payments would be identical in either case, where the funds reside has no economic significance. Hence, any transfer of the Federal Reserve surplus fund to the Treasury would have no effect on national savings, economic growth, or income.
Allowing depository institutions to pay interest on business demand deposit accounts would, in itself, have the effect of increasing demand deposit accounts at depository institutions, although CBO estimates that this effect would not be significant without the additional provision of allowing interest on required reserves. Depository institutions that do not currently offer commercial sweep accounts would offer interest-bearing business demand deposit accounts, and businesses that currently have sweep accounts would have an incentive to hold higher levels of demand deposits with the allowance of interest on business demand deposits. This authorization would not apply to non-qualified industrial loan companies, which are financial institutions controlled by commercial firms. Commercial firms are defined as firms that have at least 15 percent of annual gross revenues derived from activities that are not financial in nature in at least 3 of the previous 4 calendar quarters. Required reserves held at the Federal Reserve would increase with the rise in the level of demand deposits, increasing the earnings of the Federal Reserve and the amount that is remitted to the Treasury as governmental receipts. CBO, however, estimates that the revenue effect of that increase in required reserves would be negligible and that it is the combined effect of the payment of interest on reserves and the allowance of interest on business demand deposit accounts that would result in the revenue loss described above.
The bill would require the Federal Reserve to conduct a survey of insured depository institutions and credit unions and submit an annual report to the Congress on the availability and cost of banking services. Based on information provided by staff at the Federal Reserve, CBO estimates that the additional costs to the Federal Reserve would be insignificant. In addition, based on information from the Federal Deposit Insurance Corporation, CBO estimates that the bill would have no significant impact on the total balance of insured deposits or the likelihood that some institutions would fail and, therefore, would have no significant impact on federal spending.
Estimated impact on revenues and direct spending: CBO's estimate of the net effect of H.R. 1224 on revenues and direct spending over the 2005-2015 period is shown in the table below.
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By fiscal year, in millions of dollars--
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
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Changes in receipts 0 0 0 0 0 -752 -195 -204 -213 -224 -235
Changes in outlays 0 0 0 0 0 0 0 0 0 0 0
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Estimated impact on state, local, and tribal governments: H.R. 1224 contains no intergovernmental mandates as defined in UMRA and would impose no costs on state, local, or tribal governments.
Estimated impact on the private sector: The bill would authorize the FRB to prescribe regulations concerning the responsibilities of correspondent banks that maintain balances at the Federal Reserve on behalf of other institutions. Such private institutions as commercial banks, Federal Home Loan Banks, and corporate credit unions serve as correspondent banks for many depository institutions that are not members of the Federal Reserve. Based on information provided by the FRB, CBO anticipates that the Board of Governors would not use its authority to issue regulations unless problems arose in the crediting and distribution of interest earnings. Thus, CBO expects that this bill would not impose a mandate on the private sector. If after a period of time the FRB determined a rule was necessary, the FRB indicates the rule could require correspondent banks to pass the interest earnings back to the institutions for which they maintain required reserves at the Federal Reserve. The cost to the correspondent banks of complying with such a rule would be negligible.
Estimate prepared by: Federal Revenues: Barbara Edwards. Federal Spending: Kathy Gramp. Impact on State, Local and Tribal Governments: Sarah Puro. Impact on the Private Sector: Page Piper/Bach.
Estimate approved by: G. Thomas Woodward, Assistant Director for Tax Analysis; Robert A. Sunshine, Assistant Director for Budget Analysis.
SECTION BY SECTION ANALYSIS
Section 1. Short title
This section establishes the short title of the bill, the `Business Checking Freedom Act of 2005.'
Section 2. Interest-bearing transaction accounts authorized for all businesses
This section authorizes depository institutions to offer customers the ability to make 24 transfers per month from an interest bearing or dividend earning deposit or account into any other account maintained by that customer at that institution. This authority would not extend, however, to any industrial loan company (ILC) owned by a corporate parent that derives more than 15 percent of its gross revenue from activities that are not financial in nature or incidental to such activities and whose application for deposit insurance was approved after September 30, 2003. The Board of Governors of the Federal Reserve Board is given the authority to permit more than 24 transfers per month, and to determine that the interest-bearing accounts from which funds are transferred are subject to reserve requirements. The Committee does not intend anything in this section to affect or preempt any State law governing any depository institution which is not otherwise regulated under Federal law with respect to limitations on the transfer of funds from interest bearing accounts to any other account maintained at a depository institution by the transferring account holder.
This section also authorizes depository institutions (other than certain industrial loan companies described below) to pay interest on business accounts from which funds can be withdrawn for payment to third parties by negotiable or transferable instruments. This section does not, however, confer authority to offer demand deposits upon any institution that is prohibited by law from offering such accounts.
An industrial loan company that obtained deposit insurance prior to October 1, 2003, or pursuant to an application for deposit insurance filed before that date, is authorized to pay interest on a business NOW account, provided the industrial loan company is owned by the same parent company that owned it as of that date. Other ILCs may not offer interest-bearing business NOW accounts, unless an appropriate State bank supervisory agency determines that at least 85 percent of the gross revenues of its parent company and its affiliates were derived from activities that were financial in nature or incidental to a financial activity during at least three of the prior four calendar quarters.
Section 3. Interest-bearing transaction accounts authorized
This section repeals the prohibitions in current law on the payment of interest on commercial demand deposits. The repeal takes effect at the end of the two-year period beginning on the date of enactment.
Section 4. Payment of interest on reserves at Federal Reserve Banks
This section permits the Federal Reserve to pay interest on the reserves that depository institutions are required to maintain at Federal Reserve Banks, at a rate not to exceed the general level of short-term interest rates. The Federal Reserve is also authorized to prescribe regulations governing the payment and distribution of earnings to depository institutions that maintain balances at Federal Reserve Banks.
This section also amends the Federal Reserve Act to require the Board of Governors of the Federal Reserve to conduct an annual survey of retail banking fees, services and products provided by insured depository institutions and insured credit unions.
Section 5. Increased Federal Reserve flexibility in setting Reserve requirements
This section amends the Federal Reserve Act to eliminate the minimum statutory ratios of three percent against the first $25 million in transaction accounts held at a depository institution and eight percent against the amount above that threshold level, thereby giving the Federal Reserve greater flexibility in setting reserve requirements.
Section 6. Transfer of Federal Reserve surpluses
This section provides that during the first five years that the bill is in effect, the revenue loss associated with allowing interest payments on required reserve balances will be offset by requiring the Federal Reserve to remit from its surplus fund to the Treasury an amount equal to the estimated annual net revenue loss.
Section 7. Rule of construction
This section provides that in the case of an escrow account maintained at a depository institution in connection with a real estate transaction, the absorption of expenses incidental to a normal banking function, or the forbearance of any fee in connection with the same, or the receipt of any benefits thereof by the holder or the beneficiary of that escrow account, shall not be treated as the payment or receipt of interest for purposes of this Act and any provision of Public Law 93-100, the Federal Reserve Act, the Home Owners' Loan Act, or the Federal Deposit Insurance Act relating to the payment of interest on accounts or deposits at depository institutions.
By including this provision, the Committee intends to clarify that the current treatment of such transactions under Federal law and regulation, particularly Regulation Q of the Federal Reserve Board and interpretive letters thereunder, is unaffected by this legislation. Current law does not treat the services and benefits described by this section as the payment of interest to the beneficiary or holder of an escrow account. For example, the Federal Reserve Bank of San Francisco has indicated specifically that, for purposes of deposits by title and escrow companies, a bank's absorption of expenses related to accounting, tax reporting, courier and other services does not constitute the payment of interest and these services may be regulated as normal banking functions for which the bank may absorb the expenses (Interpretive Letter, Federal Reserve Bank of San Francisco (May 3, 1994)).
This section also provides that nothing in the legislation will be construed so as to require a depository institution that maintains an escrow account in connection with a real estate transaction to pay interest on such escrow account or to prohibit such institution from paying interest on such escrow account. Nor shall anything herein be construed to preempt the provisions of law of any State dealing with the payment of interest on post-settlement escrow accounts for taxes and insurance for residential mortgage loans.
In compliance with clause 3(e) of rule XIII of the Rules of the House of Representatives, changes in existing law made by the bill, as reported, are shown as follows (existing law proposed to be omitted is enclosed in black brackets, new matter is printed in italic, existing law in which no change is proposed is shown in roman):
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