Reg Q: When is a Premium not a Premium?

by Mary Beth Guard, BOL Guru

Question: It is my understanding that Regulation Q prohibits paying interest on demand deposit accounts. According to the regulation, giving cash, credit or merchandise (called premiums) in relation to demand deposit accounts (other than NOW accounts) is not considered interest IF:

1. Given at the time of opening or adding to the account
2. No more than two premiums per account are given per year AND
3. The total cost (including S & H etc) does not exceed: * $10 for deposits of less than $5,000 * $20 for deposits of $5,000 or more

Am I correct? I currently have, in my possession, newspaper ads from four different banks who are giving anywhere from $20 to $50 for opening a deposit account (minimum to open - $25). One of the banks is giving away a $50 gas card good at major gas stations in connection with opening an account.

Answer: Regulation Q does read as you noted above, but there's more to the story.

How are the banks you mention be advertising what they're advertising and possibly not be violating the law? There are three possibilities:

1. The Reg Q prohibition only applies to demand deposit accounts. Therefore, if the account they're advertising is a NOW account or other non-demand deposit account, the prohibition would not apply. (See Section 204.2(b) of Regulation D for the definition of demand deposit account.)
   
   
2. Perhaps, in the case of merchandise, the cost is less than the value. On that point, here's how the pertinent part of Reg Q reads:
   "Regulation Q prohibits a member bank from paying interest on a demand deposit. Premiums, whether in the form of merchandise, credit, or cash, given by a member bank to a depositor will be regarded as an advertising or promotional expense rather than a payment of interest if: 1) The premium is given to a depositor only at the time of the opening of a new account or an addition to, or renewal of, an existing account; 2) No more than two premiums per account are given within a 12-month period; and (3) The value of the premium or, in the case, of articles of merchandise, the total cost (including taxes, shipping, warehousing, packaging, and handling costs) does not exceed $10 for deposits of less than $5,000 or $20 for deposits of $5,000 or more."
   
   Maybe the bank was able to purchase gas cards in bulk at a discount from a company who is promoting particular service stations. If the actual cost of the cards to the bank was less than the maximum premium, the bank would be in compliance, even if the value of the cards was greater.
   
   
3. The third possibility, and the one that is most likely, is that they are protected by paragraph (b) of Reg Q's Section 217.101. That paragraph, which took effect May 15, 1997, embodies an important interpretation of the Federal Reserve Board. It reads as follows:
   "(b) Notwithstanding paragraph (a) of this section, any premium that is not, directly or indirectly, related to or dependent on the balance in a demand deposit account and the duration of the account balance shall not be considered the payment of interest on a demand deposit account and shall not be subject to the limitations in paragraph (a) of this section."
   
   Under this provision, if the customer's eligibility for the premium is not dependent -- either directly or indirectly -- upon the amount on deposit and the duration of the account balance, the normal restrictions on the premium (set forth in paragraph a) will not apply.

In adopting the interpretation in paragraph B, the Federal Reserve Board said they believed the exception that permits premiums given without regard to the balance in a demand deposit account and the duration of the account balance is justified because, from an economic point of view, such premiums do not constitute interest on the account. One of the reasons the Board adopted this additional exception is because the exception in paragraph (a) is restricted to the opening of or an addition to a deposit account and that has limited the ability of institutions to offer incentives to use their products, including encouraging the use of new services, such as ATM or debit cards. Before the Board adopted the exception in paragraph (b), there had been a 1981 opinion from the Executive Secretary of the DIDC (Depository Institution Deregulation Committee) saying that a bank that wanted to offer promotions to deposit customers who signed up for an ATM card and another bank that wanted to offer promotions to deposit customers who used an ATM card more than three times per month could not do so because the promotions would constitute impermissible premiums since they would not coincide with opening or adding to an account. By adding paragraph (b), the FRB got around that obstacle.

Check your state law, too. Some states have statutes that prohibit state-chartered institutions from paying interest on demand deposits. If yours has such a statute, you'll want to find out whether the state regulator is willing to recognize the same exceptions the Federal Reserve has recognized.

Originally appeared in the Oklahoma Bankers Association Compliance Informer.

First published on BankersOnline.com 1/14/02. Updated 1/17/02