Need help explaining to my LLC business customer why he can't have a business interest checking account. I've explained that Reg D prohibits it but we want to know why. I understand Reg Q prohibits paying interest on demand deposit accounts. But what was the thinking when lawmakers developed the NOW account definition in Reg D which allows paying interest on a demand deposit account (as long as the ownership is restricted to individuals and non profits). Was the NOW account developed to get around Reg Q?

Looks like you have the answer. The idea was to create an account that would allow check writing and pay interest. The benefit was only granted to consumers.

The NOW account was invented in the early 1970's by Consumers Savings Bank of Worcester, Massachusetts, a state-chartered mutual savings bank beyond the reach of Reg. Q. Before long, NOW accounts swept through New England and commercial banks demanded parity. This was the beginning of the end of Reg. Q as we knew it.

If all types of customers could have interest-bearing accounts that allowed unlimited check writing, the majority of deposits would flow into those types of accounts. Congress undoubtedly realized that could be a problem for two reasons: l) it would increase the cost of funds for banks because they would suffer a significant reduction in DDAs ("free" money) and 2) it would likely result in funds which normally would be in more stable types of deposits (such as CDs) being shifted to more volatile NOW accounts, and that could pose more of a challenge liquiditywise.

So, Congress took the middle ground. They allowed institutions to offer interest-bearing accounts with unlimited check writing, but limited the types of customers who were eligible and required the institutions, by contract, to specify that they had a right to require a certain amount of advance notice of withdrawals (something that isn't ever exercised, as a practical matter, but was certainly contemplated in Y2K planning efforts.)

In other words, it was simply an evolutionary step, just like MMDAs are. The next step in the evolutionary process will be to substantially reduce the restrictions on covered transfers/withdrawals on MMDAs. Change, however, is slow.

I don't know the exact provenance of Reg Q, but wouldn't the wholesale allowance of interest on demand accounts increase the exposure to runs on banks as happened during the Great Depression era. I know that such historical fears might not be grounded today, but that could seem to be the underlying rationale for Q. I think that's what the poster was asking about. Seen through this lens, allowing negotiable order of withdrawal accounts to limited classes would not greatly increase this risk because these are not demand accounts. There would still be justification to keep disincentives in place to keep larger commercial balances out of demand accounts because this may constitute a large portion of the institution's deposits. I don't know for sure that I'm on base here, but it seeems a logical framework to me. I am definitely open to correction. Also, I am not saying that these controls are necessarily justified today, only that this may have been the original reasoning behind the reg. Now, as to why they stuck NOW accounts' language in D, I haven't a clue. It would have made more sense in Q.

That makes sense. Thanks for the reply.

This topic is timely for some questions that have come up in my work, and I'm not certain how to answer them. Perhaps you can help.

1) Do you think the 7-day notice requirement should be included on the Reg DD new account disclosure as a transaction limitation? It is included on the signature card which is also the deposit agreement.

2) On Reg DD new account disclosures for CDs, do you think the forfeiture of interest if the account is closed in the first seven days should be disclosed - forfeiture is a requirement under Reg D. The early withdrawal penalty disclosure currently says the bank "may" charge a penalty equal to X days/months interest (depending on the term).

I have never seen either of these disclosures on Reg DD new account disclosures, though I have seen them in deposit agreements.

Any ideas?

1. No - The OSC says: "Institutions need not disclose reservations of right to require notices for withdrawals from accounts required by federal or state law."

2. You state :"do you think the forfeiture of interest if the account is closed in the first seven days should be disclosed - forfeiture is a requirement under Reg D."

Forfeiture of interest is not really the requirement - it's an early withdrawal penalty of at least seven days' simple interest on amounts withdrawn within the first six days after deposit.

So as long as your normal penalties are more then seven days of simple interest, you should be covered.

So what exactly is a "Business NOW" account and what are the qualifications for having one?

I think some banks open these for sole proprietorships and/or non-profit entities.

Yes, that's right. Non-profits and sole proprietors can play, but you have to train and control carefully to be sure your sales force stands back from the line.

What if a sole proprietor incorporates for tax purposes? Do we have to remove the interest bearing capability of their checking account, or is it allowed since they did it solely for tax purposes (or so we've been told)?

It must be removed.

And please, do not confuse LLCs with sole proprietorships. The LLC is an entity separate from its owners or members, and cannot qualify for a NOW.

One hyper-technical comment to John's point.

A LLC is not permitted to open a NOW for its benefit but it can open a NOW client trust account IF all the beneficiaries of the trust account qualify to open a NOW account. Example, a property manager organizes his/her business as a LLC and opens a client trust account for a husband/wife whose rental property will be managed by the LLC. Since the husband and wife can open a NOW account, the LLC can open the client trust account for the husband and wife as a NOW account.