I need some help understanding how earnings credit paid on a business DDA doesn't violate Reg Q.

I understand how the earnings credit works, just not how we get away with it.

Can anyone explain it to me?

It isn't paid TO the DDA, it is a credit that offsets service charges.

It's because of the splitting of hairs that says that a bank is not paying interest when it absorbs or waives a fee. So if the service charge on ABC Company's DDA account would be $32.00 this month and you provide earnings credits of $29.00 based on the balance, a credit factor, etc., the $29.00 is considered an absorption or waiver of $29.00 in fees, leaving the final service charge for the month at $3.00.

An earnings credit would become interest, however, if it exceeds the amount of fees available to waive. So, if the earnings credit for ABC Company is $35, and if you were to post the net of $3.00 ($35 credit less $32 in fees) to the account, you'd be paying interest, and that would violate Regulation Q.

Now, aren't you glad all that is going to go away in a few months?

But if the credit is greater than the service charges, it is paid. Wouldn't that be considered interest?

It can't be paid to the account. It can only net out the charges.

Thanks for the explanation.

I am trying to figure out if I have a Reg Q issue in this case:

Corporate business customer that is eligible for earnings credit. The bank has negotiated a deal with this customer that the earnings credit is to be used to offset the customer's expense of purchasing a third party sofware product which could be about $1,500 a year. The cost of the software is not charged by the bank.

Would this fall under the offset of expenses exception in Reg Q?

In every bank I've worked for with account analysis -- a total of one bank (I was there 32 years), if credits exceeded debits in a given month the excess was carried over to the next month's analysis, and any credits were lost if not used up within 12 months. In other banks, any unused credit is simply wiped out.

It depends on if the contract to provide this service is from the bank or directly through the customer. There is a very limited exception for the payment of third party services - see this and while not directly on point, if this is not the absorption of an bank expense or waiver of a bank charge, it is not allowed:

The Board was asked whether payments by a member bank to a third-party vendor (the service provider) for services provided to an escrow company that is a demand-deposit customer of the member bank would be considered indirect payment of interest on a demand deposit.

The service provider, a wholly owned subsidiary of the escrow company, provides services only to the escrow company. Under a contract between the escrow company and the service provider, fees are paid for accounting and data processing services that the service provider renders to the escrow company to account for funds that have been deposited in the demand deposit account at the member bank. Generally, the charges for services performed by the service provider are exactly the same as the value of the earnings credits available to the escrow company.

Under section 217.2(d) of Regulation Q, “[a] member bank’s absorption of expenses incident to providing a normal banking function or its forbearance from charging a fee in connection with such a service is not considered a payment of interest.” A member bank may provide a “normal banking function” through a third party without violating Regulation Q. A bank that does not have, or chooses not to allocate, the resources to directly provide services by bank employees may provide them under contract with a third-party vendor. However, the vendor may provide those services only if there is no payment “to or for the account” of the bank customers and if the provision of those services by a third-party vendor is the functional equivalent of provision directly by the bank. For example, a member bank may contract with a corporation to provide banking services to the bank for the benefit of customers of the bank. In this case, the provision of the services would be controlled by the bank and the service provider would merely be a substitute for the bank. The customer could receive an earnings credit based on the average daily balance it maintains in a demand deposit account to be applied against the costs of the services. In this example, the bank makes no payment “to or for the account” of the customer. The payments by the bank to the vendor are solely based on the contract between the bank and the vendor. Accordingly, the payments made by the bank to the vendor would not constitute interest to the customer.

However, in this case the payment provided by the bank to the service provider constitutes the payment of interest under Regulation Q. The payments are made to the service provider, a wholly owned subsidiary of the escrow company, a customer of the bank, and thus the payments for those services would be considered payments “to or for the account” of the escrow company. STAFF OPs. of September 28, 1993, and November 24, 1993.
Authority: 12 CFR 217.2(d) and 217.3.

Are you now glad that all this is going away in July?

Yes, but what am I going to do with all of these staff opinions from 20-30 years ago that I have memorized

I never memorized them, but I did remember where to find them. Now if they would just eliminate ....

What are banks that have these types of arrangements going to do after the effective date?

Analysis/earnings credit will be around...in many ways it is better for a business customer than current interest rates. And it is good for the bank..no effect on cost of funds because the account is interest free.

So, what happens if a bank has an account on analysis that has NOT been switched to an interest bearing account. Can they offset third party charges via analysis credits or will that make it an interest bearing account and affect FDIC insurance, etc.?

Need to fix my question/examples. Usually, banks would continue earnings credits for non-interest bearing accounts to keep that free money. Will use of earnings credit translate to interest and throw that account to an interest bearing dda?

You don't want interest and earnings credit on the same account.

Will it be:

>interest bearing, lose extended FDIC, affect reserves, no analysis credits (because they are already getting interest) so how can you offset third party fee
>non-interest bearing, extended FDIC, not reserve, analysis earnings credit allowed but if you offset third party fee it becomes interest bearing?

So...can you now offset third party fees only on an interest bearing account (but why would you want to?)

I am hearing that some banks are looking at a tiered approach on interest bearing accounts:

earnings credit to a point then interest.

So, in that type of account, it seems you could offset a third party fee with the EC.

Does anyone think that will no longer be "interest" and could be done in a non-interest bearing account?

Wow...this puts a different twist on an otherwise 'good' thing! I'll be interested in hearing comments on KB's scenarios!

Kathleen,

You stated:

>interest bearing, lose extended FDIC, affect reserves, no analysis credits (because they are already getting interest) so how can you offset third party fee
>non-interest bearing, extended FDIC, not reserve, analysis earnings credit allowed but if you offset third party fee it becomes interest bearing?


These were some of the scenarios an attorney I spoke to mentioned.

I keep thinking about this and I think offsetting a third party fee with earnings credits in a non-interest bearing account will still be interest and not allowed.

If you have a hybrid account, earnings credit on a level of balances and interest on the rest, you could offset a third party fee with the earnings credits as you also have interest on that account, therefore payment of interest is not prohibited.

This is probably one area in which the regulators are a little behind the times, but I have to agree with this analysis. Paying for third party fees have always been considered interest, and as such will continue to be treated as such. Such an account will probably not be illegible for unlimited FDIC insurance.

Do you mean will not be "eligible" for unlimited FDIC insurance if third party fees are covered by earnings credit? Just to make sure we are talking about the same thing.

Oh good god. Yes that is what I meant to type.

Your comment was illegible, so I wasn't sure if you meant will not be eligible!