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A ci
LEGAL HISTORY OF THE FEDERAL RESERVE SYSTEM
General statement of purpose and plan, l»#« f to review
discuss the la gal aspects of the origin and developiaent,
both fimetloaallgr «ad atruetwatllyi of
System including refMrtnofis to oourt
of the AttoMt^y Q*n*raljt ^^^ regulatioaa^ rulings,
intaiTpretatic^ia of tfet Boards with refer^nets to political
and economic aspects limited to a minimum.
A* Background
diacmstioti of f i r s t and Bm®m& banks of th# United
States> National Bank kct, and possibly ®m® reference to
foreign central banks* General indication of defects of
the banking system before the Federal Reserve Act, i.e.>
ismiastle mtrrnmy} laote of r©s#rroir of r#0arw®t etc*
B* Early Psroposals
studies of National Monetary Cormnission
and Pujo Coiroittee, with some discussion of pioposals
of Aldbplohf Willis, Waxfeurg*
C» I^gislati 1 ^ Blstoxy
Diaoission of wijor points of eontroirwsyj dtbatas
C
reports of c^i»dtt0#s f e t c .
D# fhm Origiiial Act
Osi^ral amimary of pswisions
B« Iiagal Basis
—some disc- sslon of court decisions m to constitutionality
of F©d@ral regal/itlon of banking #
11.
A* Central
Ctatlint itatt^iut of priBeipal changti in ttit Sjrstfn
both functional and structural} shifts in eicphasis, etc*
1# fhe Cwreiicy Funotion
1* Federal Reserve notes
status
(b) froosdwt for issuance
(c) (k&lateral requirements
shift 1» saphasls
{#) Redemption
(f) Interest
*—hoif ttoiy have bt#n n»M in llea of fr&n&faise tsx
2t fisdersl Reserve Mmk not#§
(m) 1913 provisions
(b) 1933 iwrgeney pi^viadons
3*
Thomas Amendment
-"•legal tender* etc*
h* §oM Reserve l e t
-*- effect on Federal Easerro Boak# and
the Discounting Ftuaetion
1*
Original eow^pt
2*
Qeneral nmWm
«-dncluding dlscsretlonarj natiare
3» Sllglbllltgr r#quir«itntt
U« Bankers9 acetptmnets
««thelr purpose and. developisscit
Ju Agrloultortl eredite
—the 1923 l o t , ete«
6* Emergency advances to nonmember banks and corporations
?• Shift in
—1935 Biuaking Act} see* 10(b)| adiranees om
Government operations} 1955 revision of Regulation Aj
8,
Business loans
-—sec. 13b, i t s Purpose, early use, mud subsequent
decline
f • Discount rates
liifttory* w i ^ ptrtioular rtf#f#iae# to
legal qoestione whidi iuvre
!Bie Stipervltoxy
. !•
Oaneral omtlins
2« Admission to membership
g csonditione
*
Village caeef eto*
3» feaalnmtions and reports
It* Capital reqairwexxbe
S* Branches
-—showing changes in the law and emphasis both
as to domestic and foreign branches
6# Heeetrrae
(a) Shift in ooneept
(b) »dapoelt liabilitiee 9 1
CiCKHpositioii of
(d) Amount
(e) Reserve and central rtstrre cities
(f) Proposals fbr changes in law
?•
Interest on deposits
(a)
PUPOM of 1933
not
(b) Meaning of *iat*rtst*
-^including som# discmssioa of absorption
of exchanre charges
(e) Tlas deposit§
~inaximuirt rates and payment before maturity
(d) Sailings deposits
8« Loans and Investments
(a) Original provisions
(b) Bffset of 1933 Baking Aot
(c) Investment securities ani corporate stocks
(d) Loans to affiliates
(t) Loans to exteBM^w officers
(f) Loans on stock and bond collateral
(f ) Real estate loans
9» Bsslations with otfaar Institiitio&s
(a) Xntarlooking dlrsetoratss
(b) Ssoixrltlss
Co) Other affiliates
(d) Bank holding
10,
Mergers and consolidations
11,
Tmst povfers of national banks
12m Foreign bmidrijag eorporations
13» EnfarGeaw&t aaaaoraa
—rawvml of dirtetora mni aagnilaloii from
lit.
1*
Relation with other bank supervisory agencies
The Collection Function
1«
Origin a l proirlttiont
2,
Status of Reserve Banks in collecting checks
3*
Par
W. tha H i §
!•
Early developuient
2«
V-loans
3#
Otter prtitut a e t l v l t l t a
U« E©3jttion witfe Dmasory
?•
fhe Crtdit
COBITOI
Fimotion
1*
Discount rates
2*
Open market operations
(a) Early mat
(b) Qtomttis of Federal Open Market Committee
(o) RaXationa
3*
Tim wmmtm
(a) 1933 mBibwiiy to
(b) Qrowlii of !!§« for artdit
tl* Special measures
(a) Margin requirements
(to) Go&suMer eredlt
(e) Heal estate credit
WS9SWVKS3R
A* Qemril
concept* atxture of govsraaftii&tl aod private
interests, etc.
f # ^>ari of Governor*
1.
Mature
-^•oFigiisal purpose ®M deveXopmut sinoe
2*
Composition and qualifications
k* Operations
!•
Status
2*
3*
BeXaticm to
Federsl l t i # n ^ Banks
1*
8ature
—as instrumentality of United States,
State tms^ltiOE^ etc*
2*
Organisation
3*
Braaehe*
k* Elation to
5* Fai#ral l i i i f i i ipiats
B*
Member Banks
of a took ownership*
•7F.
IT?.
LKJAL STAWS OF THE STSffiK IN WE G07EHI1IEST
A.
Board of Governors
B.
Open Market Committee
C.
Federal Reserve Banks
BBRije
Federal Advisory Council
Committee on the History of the
Federal Reserve System
nflTF
2/18/56
ATTACH TO HACKLEY MEMO
FROM
REMARKS
This is a memo written for
inside circulation in the *>oard of
Governors of the Federal Reserve
°"stem. It was given us as a
ionstration of the kind of work
to be expected, and may serve as a
section of the projected legal
history•
MA
X^.*"- *._ ~*? # tory °*
«j&e C o ^ i i t : ^ ^ . ; ^ J System
t&e jfeaor^u .u-**
AttUrc^
_ _ _
—
4 <st *L U<S
-
NOT FOR PUBLICATION
A Legal History of
Federal Regulation of
PAYMENT OF INTEREST ON DEPOSITS
BY MEMBER BANKS
Howard H* Hackley
Page
I,
INTRODUCTION
•
...........
II*
THE BANKING ACTS OF 1933 AND 1935
III,
THE .DIFFERENT TYPES OF DEPOSITS:
2
(A) Demand Deposits .••*.••....*.••.•.••..•••
(B) Time Deposits .
....
*.•......•
(C) Savings Deposits .
•. •
IV*
THE MEANING OF "INTEREST"
V.
VI.
ABSORPTION OF EXCHANGE CHARGES
INTEREST ON TIME AND SAVINGS DEPOSITS:
(A) Maximum Rates .......
.
(B) Determination of Applicable Maximiom Rate.
(C) Computation of interest *••.....•.•...•.,
VII.
.....
k
f>
8
lU
18
21
2i|
25
WITHDRAWAL RESTRICTIONS:
(A) Payment of Time Deposits before Maturity.
(B) Waiving Notice of VJithdrawal of Savings
Deposits
VIII. EXCEPTIONS FROM THE STATUTE
1
27
28
30
September 30, 1955.
A Legal History of
Federal Regulation of
PAYMENT OF INTEREST OH DEPOSITS
BI MEMBER BANKS
I*
INTRODUCTION
The original Federal Reserve Act contained relatively few
provisions circumscribing the banking practices of member banks of the
Federal Reserve System* It did not, for example, attempt in any way
to restrict payment of interest on bank deposits. In 1927, Congress
prohibited national banks from paying interest on time and savings
deposits at a rate higher than that authorized by State law to be paid
by State banks? ^ but this restriction was intended simply to avoid
giving national banks an undue advantage over competing State banks
and was not for the purpose of preventing unsound banking practices*
It was not until the enactment of the Banking Act of 1933 that Congress
undertook to impose restrictions on the payment of interest on deposits
by member banks for supervisory reasons* That Act was a comprehensive
measure designed to prevent the recurrence of banking crises like that
of the early 1930 !s» To that end, it provided not only for the insurance
of bank deposits but also for the regulation of certain practices which,
in the judgment of Congress, had involved abuses that had contributed
to the banking crisis. Among these practices was the payment of interest on deposits.
In the early 1930 f s, there had developed a feeling that the
payment of interest on deposits by member banks of the Federal Reserve
System should be subject to some regulation under Federal law. In competing for the deposit balances of country banks, some of the large
city banks had been paying high rates of interest on such balances,
thereby attracting an increasing volume of the surplus funds of the
country banks. It was supposed that this practice had been partly
responsible for the large number of bank failures which followed the
1929 market crash* Senator Carter Glass declared that "the payment
of interest on demand deposits has resulted for years and years in
stripping the country banks of all their spare funds, which have been
sent to the money centers for stock speculative purposes*f,3
1
Act of Feb, 25* 1927 (hk Stat. 1232). This provision, which has
not been changed, is contained in section 2U of the Federal Reserve
Act (12 U«S»C# 371)• The provision was merely an incident to an
amendment the principal purpose of which was to confirm the right
of national banks to operate savings departments.
2
Approved June 16, 1933 (U8 Stat. 162)•
3
77 Cong. Record, Pt. h9 pp. 3729, 1*165, Ul66.
-2In the early part of 1932, Senator Glass introduced a bill
which, among other things, contained provisions relating to the payment
of interest by member banks, not only on demand deposits but also on
time deposits* That bill^ would have prohibited member banks from
paying interest on time deposits of other banks at a rate in excess of
2-1/2 per cent or the current Federal Reserve Bank discount rate,
whichever was less, and on other time deposits at a rate greater than
one-half the interest rate permitted to be charged on loans by national banks. Although it met with some objections, the Glass
proposal, in a modified form, was incorporated in the Banking Act of
19336 in the following year*
II*
THE BANKING ACTS OF 1933 AND 1935
The Banking Act of 1933 added two new paragraphs to
section 19 of the Federal Reserve Act, a section previously dealing
chiefly with member bank reserve requirements. One paragraph prohibited member banks from paying any interest on demand deposits
"directly or indirectly, by any device whatsoever", but with four
specific exceptions from the prohibition which will be discussed at
a later point. The second new paragraph directed the Federal Reserve
Board to limit by regulation the rate of interest which might be paid
by member banks on time and savings deposits and also absolutely
prohibited any member bank from paying any time deposit before
H S« 3215• In March 1932* Senator Glass introduced a new bill
(S. 1*115) which similarly would have limited the rate on time deposits
but which omitted the prohibition of interest on checking accounts.
However, provisions regarding interest on both demand and time deposits
were included in a revised bill (S# 1631) which was introduced in
May 1933 and enacted later as the Banking Act of 1933•
5
The Federal Reserve Board had told the Senate Banking and Currency
Committee that, while "certain evils arise from the competitive bidding
for deposits through the payment of unduly high rates, it is believed
that it is undesirable to further regulate by law the rates of interest,
which may be paid on deposits, especially since to do so would place
member banks at a disadvantage in competition with nonmember banks*"
Memorandum enclosed with letter from Board, March 29, 1932, to Chairman,
Senate Banking and Currency Committee, (See 1932 BULLETIN 206, 220)*
At the same time, the Federal Advisory Council pointed out that "money
is a commodity like any other and that member banks should be free to
pay the rates necessary to hold their deposits*" 1932 BULLETIN 222*
6
As section 11(b) of that Act (1*8 Stat* 181, 182)*
~3~
maturity or from waiving any notice required for payment of savings
deposits unless it were waived for all savings deposits having the
same requirement*
Fursuant to the new law the Federal Reserve Board on
August 29, 1933, issued its Regulation Q, relating to payment of
interest on deposits by member banks*' In addition to paraphrasing
the statutory provisions, the Regulation undertook to define certain
terms and fixed a uniform maximum interest rate of 3 per cent for
both time and savings deposits©
In the administration of the new law various questions soon
arose and defects were noted. As a consequence, some changes in the
statute were made by the Banking Act of 1935> approved August 23* 1935*
The exceptions from the law were both n a n w e d and broadened in certain
respectsc Some of the exceptions from the prohibition against the payment of interest on demand deposits were continued only for a limited
time* The Board was required, instead ox merely authorized, to fix
different maximum interest rates for time and savings deposits in accordance with specific standards stated in the law* The absolute prohibition against payment of time deposits before maturity was relaxed*
An important change was the addition to the first paragraph of section 19
of the Federal Reserve Act of a provision expressly authorizing the
Board to define certain terms, to determine what should be deemed to be
a payment of interest, and to prescribe regulations to effectuate the
purposes of the law and to prevent evasions* The nature and purpose of
these various amendments to the law will be discussed in connection with
the several phases of the subject to which they relate*
In addition, the Banking Act of 1935 sought to meet an
objection which had been raised by the Board even before the enactment
of the 1933 Acts that regulation of interest on deposits in the case
of member banks would unfairly place such banks at a competitive disadvantage with nonmember banks* The 1935 Act amended the deposit insurance
provisions of the law' to make nonmember insured banks subject to
similar restrictions,, Specifically, the board of directors of the
Federal Deposit Insurance Corporation was directed to prohibit by
regulation the payment of interest on demand deposits in insured nonmember banks, but with the same exceptions as those prescribed by
section 19 of the Federal Reserve Act and regulations of the Federal
Reserve Board with respect to interest on demand deposits in member
banks. The board of directors of the Corporation was also directed
7
1933 BULLETIN 571. As since revised and now in effect, this Regulation
is to be found in the Code of Federal Regulations, Title 12, Part 217.
8
k9 Stat. 681w
See 1935 BULLETIN 602, 618.
9
Then contained in section 12B of the Federal Reserve Act which was
later withdrawn and made a separate Act by the Act of Sept. 21, 1950
(6U Stat. 873)• See 12 U*S.C. 1811 et seq.
-Uto limit the rate of interest or dividends payable by insured nonmember
banks on time and savings deposits and to prohibit such banks from
paying time deposits before maturity except in accordance with regulations prescribed by the directors* The directors were further authorized
to define time and savings deposits, but were given no express authority,
like that given the Federal Reserve Board, to determine what should be
deemed to be a payment of interest*
The Banking Act of 1935 Made it necessary for the Federal
Reserve Board, now known as the "Board of Governors of the Federal
Reserve System", to adopt a substantial revision of its Regulation Q
on this subject. The revised Regulation, which became effective
January 1, 1936,
included many changes necessary to conform to the
amended law and was accompanied by a "Supplement" which, as required
by the new law, fixed different maximum rates of interest payable by
member banks on time and savings deposits, using different maturities
as the basis for differentiation. One provision of the revised Regulation, however, did not become effective on January 1, 1936, along with
the rest of the Regulation, That was a provision which undertook to
define in detail what should be deemed to be a payment of interest under
the Regulation, Because of a divergence of opinion between the Board
and the FDIC on this point, this provision was at first deferred and
later abandoned; and it was not until February 1937 that a shorter and
more general definition of "interest" was finally made effective. A
fuller account of this matter will be given at a later point*
Numerous questions arose in the course of administering the
statute and the Board's regulations. These will be considered in the
following discussion of particular aspects of this matter which, for
convenience, will be treated under the following general headings:
(1) the types of depositss (2) the meaning of "interest", (3) maximum
rates of interest, (i|.) withdrawals of time and savings deposits, and
(5) exceptions from the statutory requirements.
III. THE DIFFERENT TYPES OF DEPOSITS
(A) DEMAND DEPOSITS
When the provisions regarding interest on deposits were
added in 1933 to section 19 of the Federal Reserve Act there was
already in that section a provision defining a "demand deposit" as
10
1935 BULLETIN 862. A minor revision of the Regulation had previously
been made, effective February 1, 1935 (193k BULLETIN 8l6)j but it had
made only a few changes, principally with respect to computation of
interest*
-p-
meaning any deposit payable within thirty days, as distinguished from
a time deposit which was defined as a deposit payable within more than
thirty days* These definitions had previously had significance only
for the purposes of the member bank reserve provisions of section 19*
With the enactment of the Banking Act of 1933 they became applicable
also for purposes of the interest provisions of that section. In its
1933 Regulation Q, the Board made no attempt to define demand deposits
further than already defined in the law*
The Banking Act of 1935 eliminated the statutory definitions
of demand and time deposits andj, instead, authorized the Board to
define those and other terms for the purposes of section 19 of the
Federal Reserve Act* Even under this authority, however, the Board in
its 1936 revision of Regulation Q did not undertake to prescribe a
positive definition of demand deposits * It defined a demand deposit
negatively as including "every deposit which is not a !time deposit1
or tsavings deposit,"1 as those terms were defined in the Regulation* *
In effect, therefore, the meaning of the term "demand
deposit" is to be determined by a process of elimination: a deposit
is a demand deposit if it is neither a time deposit nor a savings
deposit as those types of deposits have been defined by the Board*
(B) TIME DEPOSITS
For many years prior to 1933 it had been necessary in the
law and in the Board's regulations to distinguish between time and
demand deposits for the purposes of the member bank reserves provisions of section 19 of the Federal Reserve Act* The statute defined
"time deposits" as all deposits payable after 30 days and all savings
accounts and certificates of deposit subject to not less than 30 days1
notice before payment, and all postal savings deposits^ and in its
Regulation D, relating to reserves of member banks, the Board had set
forth detailed descriptions of time certificates of deposit, time
deposits, open accounts, and savings deposits*
As previously indicated, when the interest-on-deposit
provisions were enacted by the Banking Act of 1933* it was apparently
assumed that the existing definitions of demand and time deposits would
suffice for the purposes of the new interest provisions, as well as
the old reserve provisions, of that sectionj and in its new Regulation Q, relating to interest on deposits, the Board followed closely
the definitions previously set forth in Regulation D*
11
Regulation Q, 1936, sec, 1(a)) 1936 BULLETIN 863.
-6One important distinction, however, had to be made* For
reserve purposes, the essential difference was between time deposits
and demand deposits, the latter requiring higher reserves under the
law* For interest purposes, it was necessary, not only to distinguish
between demand and time deposits, but also to make a sharper distinction
between savings deposits and other types of time deposits, since the
new law imposed special requirements on savings deposits not applicable
to other time deposits* Savings deposits will be treated separately
in a succeeding section^ for present purposes "time deposits" are not
considered as including savings deposits*
As first issued in 1933, the Board's Regulation Q divided
time deposits into three categories} (1) time certificates of deposit;
(2) time deposits, open account; and (3) Postal savings deposits*-^
A "time certificate of deposit" was defined as including an
instrument evidencing the deposit of a specified amount payable to
bearer or to any specified person or his order, either (1) on a certain specified date not less than
30 days after the deposit,
(2) at the expiration of a specified period,
in no case less than 30 days,
(3) upon notice in writing required to be given
a certain number of days, not less than 30, before
the date of withdrawal, and
(It) in all cases only upon presentation and
surrender of the instrument.
In other words, a time certificate of deposit might be payable at a
specified date, after a specified period, or after advance notice of
a specified number of days, provided that in any case the 30-day
requirement was actually observed* For example, if the bank merely
reserved the right to require 30 days1 notice of withdrawal but did
not actually require such notice^ the deposit would not conform to
the definition*^3
A "time deposit, open account" was defined in Regulation Q
as meaning a deposit, other than a time certificate, a Postal savings
deposit, or a savings deposit, with respect to which there was a
contract under which neither the whole nor any part of the deposit
12
Reg* Q, 1933, sec, Ill(a); 1933 BULLETIN 572
13 However, since deposits under which the bank merely reserved the
right to require notice could, at that time, be classified as time
deposits for reserve purposes, the Board stated that it would not object
to payment of interest on such deposits if made before August 29, 1933,
the effective date of Regulation Q, and if such certificates of deposit
were terminated as soon as possible. 1933 BULLETIN 652*
-7might be withdrawn prior to the maturity date, which was required to
be not less than 30 days after the date of deposit or after the giving
of not less than 30 days1 written notice* The essential feature was
that a time deposit, open account, unlike a time certificate, did not
need to be represented by an instrument which must be presented and
surrendered at the time of payment; and this was because the open account would be used continuously for deposits and withdrawals in
varying amounts, whereas a time certificate evidenced a single fixed
amount deposited at one time and normally withdrawn at one time*
"Postal savings deposits" were defined simply as deposits of
funds consisting of Postal savings funds deposited under the Postal
Savings Act* They did not conform to Regulation Q f s definition of
"savings deposit" (to be considered later) j but, because of amendments
made by the Postal Savings System to its own regulations so as to permit
withdrawals only at the end of successive 30-day periods, the Board
concluded that such funds, when deposited in member banks, might properly
be classed as time deposits« -1
In November 1933, the Board published four sample forms of
certificates of deposit which would comply with the regulatory definitions*^5 However, no particular form was required; and the certificates
used by member banks assumed a wide variety of forms* In some instances
banks issued certificates which provided alternative maturities, for
example, a specified maturity date and also provision for withdrawal
prior to that date after a prescribed period of advance notice* The
Board did not "look with favor" upon such certificates but nevertheless
held that they complied with the Regulation*^ Frequently, however,
the major question was not whether the certificate met the requirements of the definition of a time certificate but whether the rate of
interest provided for under such a certificate with alternate maturities
was within the maximum rates prescribed by the Board* This matter
will be dealt with in a later section*
Banking practices sometimes gave rise to a problem as to
whether funds placed in a time deposit actually would not be withdrawn
within 30 days* Thus, in 1950 such a question arose with respect to
the deposit by the trust department of a member bank in its own commercial department of commingled uninvested funds belonging to various
1L
1933 BULLETIN 768*
15
1933 BULLETIN 708*
16 In 193ii, the Board approved a certificate payable at the end nf
six or twelve months but with a right in the depositor to withdraw the
deposit at an earlier date upon giving thirty daysf written notice,
193lt BULLETIN h3t In 1936, the Board raised no objection to a certificate payable three, six, nine, or twelve months after date.
1936 BULLETIN 2li7,
-8trusts administered by the trust department. The funds deposited were
not identified as belonging to particular trusts; yet it was known
that in some instances the trust department might be required to disburse funds of certain trusts at any time without advance notice*
The Board held, however, that such a deposit of commingled trust funds
could be regarded as complying with the Regulation if the amount of
the deposit was determined on "a reasonable and conservative basis"
in the light of monthly reviews of anticipated requirements for the
disbursement of trust funds by the trust department, if the deposit
was subject to an agreement complying with the requirements of the
Regulation, and if the bank was satisfied that the practice was not
inconsistent with State law relating to trust administration or
otherwise*1?
In order to make administration of the law more "flexible",
the Banking Act of 1935* as has been seen9 gave the Board broad
authority to define terms, including the term "time deposits*" However, when the Board issued its revised Regulation 0, effective
January 1, 1936,1" it made few changes in the provisions defining the
various types of time deposits, although the earlier definition of
"Postal savings deposits" was omitted as no longer necessary.
One important change, however, was made by the 1936 revision
of the Regulation. Before 1933 the Board, for reserve purposes, had
ruled that a time deposit was to be considered as becoming a demand
deposit as soon as it actually became payable "within 30 days."19
The same position had been followed after 1933 under Regulation Q.^0
Hottfever, after the repeal in 1935 of the statutory definitions of time
and demand deposits, the Board in its revision of Regulation Q took
a different position. It made it clear that a deposit which met the
definition of a time deposit at the time of its deposit continued to
be a time deposit until its maturity or the expiration of the period
of advance notice required, even though it became payable within
30 days; but after the maturity date or the expiration of the period
of notice it would then become a demand deposit.
(C) SAVINGS DEPOSITS
Under the Board!s regulations, the definition of the term
"savings deposit" has always consisted of three elements: (1) reservation of the right to require notice of withdrawal; (2) the purpose of
the deposit or the nature of the depositor; and (3) representation by
a passbook or other form of receipt.
17
1950 BULLETIN U u
18
Reg. Q, 1936, sec* 1(b), (c), and (d); 1935 BULLETIN 863,
19
20
1919 BULLETIN 655*
193li BULLETIN 180.
-9~
As has been seen, the principal requirement of the
definition of a "time deposit" is that it must be payable either on a
specified date not less than 30 days after the date of deposit or be
subject to not less than 30 days1 written notice of withdrawal, and in
the latter case such notice of withdrawal must actually be given in
all cases# A deposit may be classified as a savings deposit, hoxrever,
if (in addition to meeting the other requirements) it is subject to
an agreement under which the depositor is required or may at any time
be required by the bank to give notice in writing of an intended withdrawal not less than 30 days before the withdrawal is made*2-*- The
right to require notice need not be exercised by the bank; and, as a
matter of practice, banks seldom exercise the right* Consequently,
savings deposits, unlike other types of time deposits, are in effect
payable on demand*
As the result of their actual availability for withdrawal
at any time, savings deposits have always constituted an especially
favored class of deposits both for reserve purposes and for purposes
of payment of interest. On the one hand they are subject to far lower
reserve requirements than demand deposits} on the other hand, unlike
demand deposits, they may bear interest. It is because savings deposits
have been accorded such special privileges that the Board has been
careful to define and limit such deposits in a manner designed to prevent abuses of these privileges and make certain that any deposit
classified as a savings deposit is, in fact, a deposit of savings
rather than of funds which will be checked against and used for commercial purposes. The second and third of the elements of the definition of a "savings deposit" mentioned above are in the nature of safeguards against such abuses*
In its 1933 Regulation Q, the Board provided that, in order
to constitute a "savings deposit", a deposit must consist of funds
"accumulated for bona fide thrift purposes,"22 Recognizing that this
was a purely subjective requirement - a matter of intent - the Board
hesitated to elaborate on what was meant by "bona fide thrift purposes";
it felt that this should be left to the judgment of each member bank*
Apparently, however, the Board was pressed for a further explanation;
and in a published ruling it stated that "presumptively" the phrase
would include deposits of funds of relatively small amounts accumulated
by persons of limited financial means, and funds intended to provide
21 Reg. Q, 1936, sec* 1(e); 193? BULLETIN 863. A similar requirement
had been applied to savings deposits for reserve purposes as early as
1915. See 1915 BULLETIN 173.
22
Reg, Q, 1933, sec. V(a); 1933 BULLETIN 573.
-10for old age, unforeseen contingencies, or anticipated expenditures for
such items as Christmas or vacation expenses, tax liabilities, and
insurance premiums.^ The Board also stated that deposits of corporations in most cases probably would not meet the test and that funds
deposited by one bank in another bank would not constitute funds accumulated for bona fide thrift purposes. In the end, however, the
Board conceded that none of these considerations could be regarded as
conclusive*
Eventually the subjective requirement had to be abandoned*
In its 1936 revision of Regulation Q the Board substituted a requirement related to the nature of the depositor rather than the purpose of
the deposit* The revised Regulation provided^ that a "savings deposit"
must consist of funds "*- * -* (i) deposited to the credit of one or more
individuals, or of a corporation, association or other
organization operated primarily for religious, philanthropic, charitable, educational, fraternal or other
similar purposes and not operated for profit, or (ii) in
which the entire beneficial interest is held by one or
more individuals or by such a corporation, association
or other organization, -* # •*."
The new test, in other words, was not the thrifty intent of
the depositor but the character of the person or organization in whose
name or for whose benefit the deposit was made. If the depositor was
an individual his deposit could be classed as a savings deposit whether
or not he had any savings purpose in mind#25 A corporation, however,
could have a savings deposit only if it was operated for one of the
specified eleemosynary purposes and only if it was not operated for
profit* An ordinary business corporation operated for profit could
not have savings accounts.2"
Such organizations as churches, charity hospitals, endowed
educational institutions, and fraternal orders could clearly have savings deposits under the new definition. There were other types
23
1931 BULLETIN 389*
2\x Reg* Q, 1936, sec* 1(e)} 1935 BULLETIN 863.
25 After the death of an individual depositor, the deposit could
continue as a savings deposit if the entire beneficial interest would
vest in other individuals or organizations of the kind mentioned in
the Regulation; and where there was any uncertainty on this point, the
Board offered no objection to continued classification as a savings
deposit "for a reasonable time after the death of the depositor".
1939 BULLETIN 851.
26
1936 BULLETIN 191.
-11of organizations, however, as to which the answer was not so clear
and the Board received numerous inquiries on this point. Among those
considered eligible to have savings deposits the Board listed professional associations, trade associations, businessmen's clubs,
recreational and social clubs, labor unions, volunteer fire companies,
cemetery associations, and police and firemen's pension or relief
associations; but the Board held that the definition did not cover
building and loan associations, mutual or cooperative insurance
associations, cooperative marketing associations, credit unions, and
States and municipalities«^7
The Board adhered closely to the objective test of the nature
of the depositor, regardless of the purpose for which the funds deposited were to be used. Thus, deposits made by an individual were
held to be properly classed as savings deposits, even though they were
to be used by the individual in his business,28 On the other hand,
funds deposited in the name of a municipality could not be considered
savings deposits even though they were to be used for educational or
charitable purposes, since the municipality was operated primarily for
governmental rather than educational or charitable purposes#29 By the
same token, however, if the particular municipality was not a city or
a county but a "school district" or "poor district", its primary purposes were educational or charitable and its funds, therefore, could
be deposited in a savings account.
The "passbook" had long been one of the most characteristic
indicia of savings deposits. As early as 1915, the Board had taken
the position, for reserve purposes, that savings accounts must be
"evidenced by pass book, certificate of deposit, or similar form of
receipt" which had to be presented to the bank whenever any withdrawal
was made*30 These requirements, of course, were designed to prevent
savings deposits from being used like ordinary checking accounts. A
depositor could still pay a creditor by giving him a draft on his
27
1937 BULLETIN 1073*
28
1936 BULLETIN 120*
29
1936 BULLETIN 2itf.
30
1915 BULLETIN
73.
-12savings deposit; but, since the creditor could not cash the draft
without presentation of the passbook, the draft itfould have to be accompanied by the passbook. Until the passbook was returned to him the
depositor could not draw any additional drafts on his account. Only
one such draft could be outstanding at any time.31
In its 1933 Regulation Q, relating to interest on deposits,
the Board adopted the same requirements with respect to the necessity
for passbooks in connection with savings deposits as had been followed
in the past in applying the member bank reserve provisions of the law,32
The Board also followed its earlier precedent that retention of the
passbook by the bank was not sufficient; it must be held by the
depositor and presented at the time of any withdrawal,33
The Board never attempted to define the term "passbook" with
any particularity, although it has stated that a passbook "means an
account book in which deposits and withdrawals are entered";3u and that
it should afford "a continuous record of the transactions in the
account•
Like earlier regulations relating to reserves of member
banks, Regulation Q, as first issued in 1933* required that the passbook
be presented when any withdrawal was made from a savings deposit, even
when made by the depositor himself•36 This requirement, however, was
modified in the 1936 revision of the Regulation so as to permit
31 The reasons for requiring presentation of the passbook upon withdrawals do not apply to deposits in a savings account; a depositor
could make deposits by mail without sending along his passbook*
1951 BULLETIN 19*
32
Reg. Q, 1933, sec. V(a); 1933 BULLETIN 573.
33 193h BULLETIN 5U2.
3U In this case the Board held that a book used in connection with a
Christmas Club account could not be considered a passbook within the
meaning of the Regulation. 1936 BULLETIN 120. In another case the
Board ruled that a certificate of deposit which contemplated that the
full amount of the deposit would be repaid upon surrender of the certificate could not be regarded as an "other form of receipt." 1931*
BULLETIN 390,
35
19 5U BULLETIN U60.
36 Thus, under the Regulation as then worded a member bank was not
permitted to charge a customer's savings deposit with the amount of
payments due on the customers note to the bank, even though under
instructions from the customer, without presentation of the passbook
in each such instance. 1935 BULLETIN 239.
-13withdrawals by the depositor himself without presentation of the
passbook; and it was made clear in a footnote that payment could be
made to the depositor, not only over the counter at the bank, but also
through the mails or otherwise. As to withdrawals by persons other
than the depositor, even by an agent of the depositor, the rule was
not changed; presentation of the passbook was still necessary.37 Even
as to itfithdrawals by the depositor himself the Board felt that some
written order or receipt was desirable and that telephone or other oral
requests for payment should not be approved.38
In one other respect the rules regarding passbooks were
liberalized by the 1936 revision of Regulation Q. Previously, retention of the passbook by the bank had been deemed insufficient. The
Regulation now made it permissible for the bank to hold the passbook
where it was part of an estate being administered by the bank as
trustee or where it was held by the bank as security for a loan.
As contrasted with these liberalizing changes, the 1936
revision of Regulation Q made one restrictive change. It eliminated
the words "or other form of receipt", thus making it necessary thereafter for a savings deposit to be evidenced by a passbook in all cases.
The development of machine equipment for the processing of
deposits gave rise in 195k to a question as to whether punch-cards
used in connection with a "payroll deduction savings plan" for the
benefit of employees of a certain corporation could be regarded as
"passbooks". The Board held that the punch-cards differed materially
from a passbook as generally understood and that such accounts could
not be classified as savings deposits.39
This interpretation was criticized as preventing member
banks from performing economically a desirable service for which there
was wide-spread demand. The Board adhered to its position that a
punch-card could not be considered a passbook; but, in order to meet
the situation, it amended Regulation Q, effective May 16, 1955*
so as
37 The Board permitted one exception: It held that transfers from
savings accounts to FHA mortgage accounts in payment of monthly installments due on insured mortgages, but without presentation of the
passbook, would not be considered a violation of the Regulation.
1939 BULLETIN 850,
38
1936 BULLETIN 62lu
39
195U BULLETIN i*60,
hO 1955 BULLETIN 500. An identical amendment was made at the same
time in the definition of "savings deposits" contained in Regulation D,
relating to reserves of member banks. In addition, the FDIC adopted an
identical amendment to its regulations relating to payment of interest
on deposits by nonmember banks.
-mto permit a member bank, if it so desired, to classify a deposit as a
savings deposit, even though not represented by a passbook, provided
withdrawals were permitted only through payment to the depositor himself
and not to any other person, whether or not acting for the depositor*
In other words, such a deposit, unlike one represented by a passbook,
could in no event be paid to any third personal
XV.
THE MEANING OF "INTEREST"
Perhaps the most difficult problem encountered by the Board
in its administration of the interest-on-deposit provisions of the law
has been the difficulty of determining whether particular practices of
member banks involve a payment of interest. The problem arises with
respect to both demand deposits and time and savings deposits, although
it is not, of course, of any significance in the case of time and savings
deposits unless the stated rate paid by a member bank is the maximum
rate authorized by the Board's regulations*
With respect to the prohibition against payment of interest
on demand deposits, the language of the law is extremely broad. It
prohibits payment of interest on such deposits directly or indirectly
tf
by any device whatsoever". With respect to time and savings deposits,
the law does not use such all-inclusive language, but, in its Regulation Q the Board has employed language as broad, if not broader, than
that used in the law with respect to demand deposits. Section 3 of
the Regulation provides that, except in accordance with the provisions
of the Regulation, no member bank shall pay interest on any time or
savings deposits "in any manner, directly or indirectly, or by any
method, practice, or device whatsoever."
It seems obvious that the law and the Board's Regulation
contemplate something more than the direct payment of interest at a
stated rate. The problem arises in determining the extent to which it
is necessary to go beyond the customary concept of interest in order
to give full effect to the purposes of the law. A narrow construction
of the meaning of the term "interest" could easily permit evasions of
the law* On the other hand, a far-reaching construction might cover
banking practices which are generally regarded in the banking world
as legitimate advertising devices*
CI In an interpretation, the Board made it clear that, while the
depositor could not draw a check on his account payable to a third
party, it was not necessary for the depositor to go to the bank in
person to make a withdrawal, since it would be permissible for the
bank to mail him a check or deliver to a messenger a check payable
to the depositor. 1955 BULLETIN 61*8.
-15For a time the Board endeavored to give definite answers to
the many inquiries received by it as to whether various practices involved an indirect payment of interest on depovsits under the law and
the Board1 s Regulation Q. Some of its answers were published in issues
of the Federal Reserve Bulletin^ in many cases, however, they were
contained in unpublished letters.
After it was given express statutory authority by the Banking
Act of 1935 to define "interest'1, the Board sought, by a detailed
regulatory definition, to set at rest some of the questions most frequently raised. Its 1936 revision of Regulation Q, as first approved
by the Board, contained the following definition:W
"The term 'interest1 means a payment, credit, service, ,
or other thing of value which is made or furnished by a bank
as consideration for the use of the funds constituting a
deposit and which involves the payment or absorption by the
bank of out-of-pocket expenses (i»e., expenses arising out
of specific transactions for specific customers and definitely attributable to such transactions as distinguished
from overhead and general operating expenses), regardless
of whether such payment, credit, service, or other thing of
value varies with or bears a substantially direct relation
to the amount of the depositor's balance.
"The term 'interest' includes the payment or absorption
of exchange and collection charges which involve out-ofpocket expenses, but does not include the payment or
absorption of taxes upon deposits whether levied against
the bank or the depositor nor the payment or absorption of
premiums on bonds securing deposits where such bonds are
required by or under authority of law*
H2 Thus, the Board held that payment of the premium on a bond given
to secure deposits of public funds (1933 BULLETIN 500), absorption of
exchange or collection charges (193)4 BULLETIN 39h), and the giving of
an allowance for payment of a banker's acceptance before maturity
(193li BULLETIN 303) resulted in an indirect payment of interest. On
the other hand, it held that absorption by a member bank of trivial
amounts for expenses for such items as isolated exchange and collection charges, telephone calls, and telegrams would not be considered
"interest" (193U BULLETIN 8II4), and that an allowance of a credit
equal to the earning value of a depositor's account in determining the
amount of service charges to be assessed against the depositor did not
involve an indirect payment of interest (1931 BULLETIN 1*3).
1*3 Reg, Q, 1936, sec. I(f)j 1935 BULLETIN 863.
-16"NoWithstanding the foregoing, the payment or absorption of isolated items of out-of-pccket expense in
trivial amounts and not of a regularly recurrent nature,
where the charging of such items to customers would cause
undue friction or misunderstanding, will not be deemed to
be a payment of interest, provided that the bank acts in
good faith and does not utilize the absorption of such
items as a basis for soliciting accounts or obtaining an
advantage over competitors and provided further that
the bank maintains and makes available to the examiners
authorized to examine the bank a record showing the amounts
of such items paid or absorbed by it, the dates of such
payment or absorption, and the names of the customers for
whom such items were paid or absorbed."
This comprehensive definition of "interest", however, never
became effective*
The Banking Act of 1935* as previously noted, had made the
restrictions on payment of interest on deposits applicable to nonmember
insured banks as well as member banks, although with some differences.
Under the amended law the FDIC had drafted its own regulation governing
payment of interest by nonmember insured banks; and in general it was
similar to the Board's revised Regulation Q, In one respect, however,
there was a difference of opinion: the FDIC felt that absorption of
exchange and collection charges should not be declared to be a payment
of interest as contemplated by the Board's proposed definition. This
particular question will be given special consideration at a later point*
It is sufficient here to note that the Board's effort to define "interest"
by regulation was unsuccessful and that, when the revised Regulation Q
went into effect on January 1, 1936, the "interest" definition was not
included*
Eventually, on February 11, 1937, the Board and the FDIC
agreed to amend their respective regulations to include an identical
definition of interest reading as follows:
"Within this regulation, any payment to or for
the account of any depositor as compensation for the
use of funds constituting a deposit shall be considered
interest."
In connection with this action the Board and the FDIC issued a joint
announcement stating that the effect of this definition was to "declare
existing law rather than to interpret and apply the lax* to particular
practices" and that thereafter, under the regulations of both agencies,
-17the question of what in a particular case would be considered a payment
of interest would be "a matter of administrative determination under
the general law in the light of experience and as specific cases may
develop. « W
About the same time - in the Spring of 1937 - the Beard
adopted a general policy of not attempting to issue detailed interpretations or rulings with respect to whether particular practices involve
a payment of interest, except and until the facts and circumstances of
a specific case might be developed by examinations of the member bank
involved. The Board preferred to rely upon the cooperation and good
faith of member banks in adapting their practices to conform to the
spirit and purpose of the law. Many years later, in 195U, the Board
stated that its general policy of not passing on such questions except
after bank examinations had "proved to be the most feasible basis for
dealing with questions of this kind*
As a consequence of the adoption of that general policy the
Board after 1937 published fewer interpretations as to the meaning of
"interest" under Regulation Q.
In two instances, after development of the facts through
examinations of the banks involved, the Board held that the practices
in question resulted in indirect payments of interest on deposits.
In the first case, the Board in 19ll3 took the position that absorption
of exchange charges by a particular member bank involved an indirect
payment of interest on demand deposits in violation of the law*
That ruling will be mentioned again at a later point. In 19$h, the
Board held that, where a member brnk, in consideration of the maintenance by an insurance company of an increased deposit balance, made
a payment to another depositor for the benefit of the insurance company, that payment was to be regarded as having been made "for the
account of" the insurance company as compensation for the use of its
funds on deposit and was therefore a violation of the law and the
Board1s Regulation.k7
kh
1937 BULLETIN 187.
16
195U BULLETIN $89.
U6 19U3 BULLETIN 817.
k7
I9$h
BULLETIN 589,
-18In some other instances, even though the facts were not
developed through bank examinations, the Board departed from its
general policy and published its views as to the effect of particular
practices, apparently because the answers in these cases seemed
reasonably clear*
Thus, in 1939 the Board held that a member bank's offer to
give a $1,00 credit to any depositor who introduced a neitf depositor
to the bank was not a payment of interest but merely a payment for the
depositor's service in bringing a new customer to the bank^o
In 19Wl, the Eoard held that the use by a member bank of the
typical monthly account analysis in determining the amount of service
charges to be imposed against its depositors was simply an internal
arrangement which involved no payment to the depositors or the giving
of any credit which increased the amount, of their balances and was
not, therefore, a "payment of interest"»4^ This case was distinguished
from absorption of exchange charges on the ground that the latter in-*
volved a definite payment of actual out-of-pocket expenses on behalf
of a depositor, while analyses of accounts for service charge purposes
resulted in no payment to the depositor but only an omission by the
bank to make a charge for its services in handling the depositor's account.
Again, in 195U, while referring to its general policy of not
passing on "interest" questions in the absence of a bank examination,
the Board held that, where a member bank, in calculating interest on
a loan made to a depositor, first deducted from the principal the
amount of a cash reserve set aside in a demand deposit account, the
arrangement "would involve no question as to a payment of interest on
the deposit."50
V.
ABSORPTION OF EXCHANGE CHARGES
Reference has been made to the disagreement between the Board
and the FDIC as to whether absorption of exchange charges should be
regarded as an indirect payment of interest. Some further and special
discussion of this matter seems warranted because it constituted one
of the principal problems - and certainly the most notorious - that
developed in the administration of the provisions of law relating to
the payment of interest on deposits.
U8
1939 BULLETIN 559.
U9
19UU BULLETIN 13•
50
195U BULIETIN 589.
-19It should first be understood that an "exchange charge" is
a charge made by a bank when paying a check drawn upon it and presented
through the mails for payraent (as distinguished from presentation "over
the counter"). Such charges are now made only by a relatively few
banks - generally referred to as "nonpar" banks ~ in certain areas of
the country*>l The charge is made against the party presenting the
check for payment - normally another bank - and usua3-ly amounts to
1/8 or 1/10 of one per cent of the amount of the check.
Obviously, the original payee of a check - one, for example,
who accepts the check instead of cash in payment for an article sold
by him - might very well complain if, when the check is paid, he
received some amount less than the face value of the check. However,
this seldom happens. Somewhere in the course of collection of the
check one of the collecting banks "absorbs" the exchange charge. For
example, a check for ^1,000 on a nonpar bank is deposited by the payee
in his own bank and that bank sends it to its city correspondent bank
which in turn sends the check to the drawee nonpar bank for payment.
The latter, after deducting a $1.00 exchange charge, remits $999 tc
the city correspondent! but the city correspondent credits the payee*s
own bank for the full $1,000 and that bank in turn credits the payee
with the full amount of the check. In other words, the city bank has
itself paid or absorbed the amount of the exchange charge. However,
it did so for a price• It has an arrangement with the payee1s bank
under which that bank agrees to maintain a "compensating" deposit
balance with the city bank in return for the latter?s willingness to
absorb exchange charges.
Before the enactment of the Banking Act of 1933 prohibiting
the payment of interest on demand deposits, there were banks which
absorbed exchange charges in the manner above outlined. However, after
the prohibition was enacted, some banks, no longer able to pay interest
on demand deposits directly, began actively to solicit the accounts of
other banks by offering to absorb exchange; and their solicitations in
some instances were extremely successful. Some of the absorbing banks
benefited by a rapid and substantial increase in the volume of deposits
carried with them by the banks for which they had agreed to absorb
exchange charges.
5l As of December 31, 195k, out of a total of 13*7ii7 commercial banks,
there were 1,787 nonpar banks, located principally in Alabama, Arkansas,
Florida, Georgia, Louisiana, Minnesota, Mississippi, Missouri, North
Carolina, North Dakota, South Carolina, South Dakota, Tennessee,
and Texas.
-20Shortly after the new law was passed the Board took the
position that absorption of exchange as a means of attracting and
retaining deposits was an indirect payment of interest if the amount
absorbed bore a direct relation to the amount of the deposit.52
Later, as previously noted, the Board proposed in its 1936 revision
of Regulation 0 to declare that absorption of exchange tfss a payment
of interest, whether or not the amount absorbed varied with the amount
of the deposit balance* It was at this point that the FDIC expressed
its disagreement with the Board1s position* In the hope of achieving
harmony, the effective date of the proposed definition was deferred;
but efforts to reach an agreement were not successful. Finally, on
February 11, 1937, as already indicated, the Board and the FDIC adopted
an identical definition of "interest" which was couched in general
language and made no reference to the matter of absorption of exchange.
In September 19h39 the Board published its ruling that under
the facts of a particular case, developed by successive bank examinations, the absorption of exchange by a certain national bank constituted an indirect payment of interest on demand deposits in violation of the law* 53 This ruling brought immediate protests from nonpar
banks•
Among other things, the Board was charged with attempting to
force par clearance upon nonpar banks. In fact, the heart of the
matter was not so much the question of payment of interest on deposits;
that question was inextricably interwoven with an older and more
fundamental question relating to the propriety of exchange charges
themselves - the so-called "par clearance controversy" which had raged
in the 1920fs when the Federal Reserve System had sought to bring about
nationwide par collection of checks. If banks were precluded from
absorbing exchange charges as a consequence of the Board1s ruling and
if"the cHarges had to be passed back to the payees of checks drawn on
nonpar banks, those banks would undoubtedly be faced with complaints
from their own customers and might be forced to discontinue the making
of such charges - a practice which the nonpar banks readily admitted
was a lucrative source of revenue.
The Board's 19U3 ruling revived the par clearance controversy.
In January 19UU, there was introduced in Congress a bill^u designed to
nullify the effect of that ruling* It would have amended the interest
provisions of section 19 of the Federal Reserve Act to declare expressly
52
193U BULLETIN 39lu
53
19U3 BULLETIN 817.
5U
H. R. 3956, 78th Cong., 2d. Sess.
-21that the prohibition against the payment of interest on demand deposits
should "not be deemed to prohibit the absorption of exchange or collection charges by member banks." In March 19hh this bill passed the House
of Representatives, but in December of that year it was defeated in
the Senate by a vote of U5 to 25. ^
While member banks, following the Board's ruling, generally
ceased to absorb exchange charges, insured banks which were not members
of the System continued the practice. The FDIC amended its interest
regulations by adding a footnote which stated that the absorption of
exchange charges in connection with the routine collection of chqcks
drawn on other banks would not constitute a payment of interest.5o
Meanwhile, the Board, in an effort to alleviate the problem,
sent to all member banks on June 25, 19U5 a circular letter" stating
that, as an administrative matter, the absorption of exchange charges
in amounts aggregating not more than -;?2 for any one depositor in any
calendar month would be considered as trivial and disregarded, provided
the bank kept such records as the appropriate supervisory authority
might require for reconcilement purposes.
This action, of course, did not resolve all the difficulties.
The problem continues to exist, sometimes acutely, in certain parts
of the country• Since insured nonmember banks may freely absorb exchange charges, member banks are placed at a competitive disadvantage;
yet both classes of banks operate under substantially similar provisions of law. The situation has caused some member banks to arrange
with nonmember insured banks for the absorption of exchange on nonpar
checks sent to them by the member bank, provided the member bank maintains a "compensating" deposit balance with the nonmember bank. By
such an arrangement a member bank is enabled to solicit deposits by
offering to collect nonpar items at par, without itself absorbing the
exchange charges on such items.
VI.
INTEREST ON TIME AND SAVINGS DEPOSITS
(A) MAXIMUM RATES
The Banking Act of 1933 authorized the Board to prescribe
different maximum rates of interest on time and savings deposits according to different maturities, different conditions as to withdrawal,
or different locations. In its 1933 Regulation, however, the Board
chose to fix the same maximum rate - 3 per cent - for all time and
55 For a detailed account of the absorption of exchange charge
controversy, see 30 VIRGINIA LAV REVIEW 603.
$6
See 12 Code of Federal Regulations, § 329.2, footnote 6.
57
19U5 BULLETIN 56U.
-22savings deposits*58 Subsequently, effective February 1, 1935* the
Board reduced the maximum to 2-1/2 per cent, again for all types of
deposits4 $9
The Banking Act of 1935 made it mandatory for the Board to
prescribe different maximum rates according to one or more of the
three standards previously stated or a fourth standard of differentiation added ty the amending Act: varying Federal Reserve Bank discount rates* In compliance with this statutory mandate* the Board
selected different maturities as the most appropriate basis for fixing
different maximum rates of interest. In a separate "Supplement" accompanying its 1936 revision of Regulation Q, the Board prescribed the
following maximum rates of interest accruing after January 31, 1936:^
2-1/2 per cent for savings deposits, Postal
savings deposits, ard time deposits having a s tated
maturity of 6 months or more^l or payable on written
notice of 6 months or more}
2 per cent for time deposits with maturities (cr
a period of notice) of less than 6 months but not less
than 90 days; and
1 per cent for time deposits with maturities (cr
a period of notice) of less than 90 days.
These requirements have never since been changed*
On each of the occasions when maximum rates were fixed by
the Board, an exception was allowed with respect to deposit contracts
entered into in good faith prior to a specified date antedating the
effective date of the new rates. Thus, rates higher than the 3 per
cent maximum fixed by the Board in 1933 could be paid on such contracts
entered into before June 16, 1933. Wien the rate was reduced to
2-1/2 per cent effective February 1, 1935, contracts calling for a
higher rate were not disturbed if executed before December 18, 193U*
Finally, the 1936 Supplement permitted higher rates than those prescribed by it to be paid on deposits entered into before December..!,
1935« In each instance, however, it was made clear that the exception
applied only to contracts which could not legally be terminated or
modified by the member bank at its option and "without liability0
58 Reg* Q, 1933, sees. III(c) and V(c)j 1933 BULLETIN 573, 5'7>4* The
maximum was made effective as to any interest accruing after October 31*
1933.
$9
Reg, Q, 1935, sees. IIl(c) and V(c)j 193h BULLETIN 817, 8l8*
60
1935 BULLETIN 867.
61 Though "six monthsff normally means six calendar months, the Board
offered no objection to payment of interest at a rate of 2-1/2 per cent
on a deposit maturing 180 days after date* 1951 BULLETIN 273.
-23In order that depositors might have actual knowledge that
the rate of interest paid on their deposits would be subject to modification if the Board should change the maximums, the Board suggested
that banks stamp on each time certificate of deposit a legend to the
effect that the ratems subject to change to such extent as might be
necessary to comply with requirements of the Board made from time to
time pursuant to the law*62
In addition to being limited by the maximum rates of interest
specifically fixed by the Board, member banks are subject to a further
limitation in this respect,, A provision of section 2k of the Federal
Reserve Act, enacted in 192?* prohibits any national hank from paying
interest on time and savings deposits at a rate higher than that
authorized to be paid on such deposits by State backs in the State in
which the national bank is located. Consequently, if State law happeis
to prescribe for State banks a maximum rate lower than that fixed by
the Board in its Supplement to Regulation Q, neither a member: State
bank nor a national bank in that State could pay interest at a rate
greater than the State maximum. Regulation Q itself explicitly recognizes this fact in a provision stating that tjie rate paid by any member
bank shall not exceed whichever is the lesser of the rate fixed by the
Supplement to the Regulation or the rate fixed underihe laws of the
State* 63
It should be noted that prior to the Banking Act of 1935,
the statutory provisions with respect to interest on time and savings
deposits applied to deposits received by foreign branches of member
banks, even though the prohibition against the payment of interest on
demand deposits was specifically made inapplicable to deposits received
only at offices located in foreign countries. Recognizing that competitive conditions in foreign countries might justify different treatment, the Boaari provided in its Regulation^ that the rate payable on
deposits at offices located outside the United States should not exceed
the maximum rate generally prescribed by the Regulation or nsuch higher
maximum rate" as the Board might prescribe for payment in the localities
£5 1933 BULLETIN 768, However, when the maximum rate was reduced to .
2-1/2 pier *cent in 1935* the Board held that a member bank could continue
to pay a higher rate on a certificate having a definite maturity, even*:
though it bore the legend referred to above; but, if the deposit was
payable after 30 days1 notice orvas a savings deposit whidi could be
terminated by the bank after reasonable notice to the depositor, the
Board held that the deposit could and should be modified to conform, to
the reduced maximum rate. 1935 BULLETIN 107*
63 Reg. Q, 1936, sec. 3(c). labile many States prescribe no maximum interest rates, there are some which fix a statutory maximum ani others
which authorize the State banking authorities to prescribe maximum rates
of interest. In the latter cases, whenever the rates were lowered or
raised by the State authorities it was necessary for the Board to determine whether the State rate was actually applicable to all State banks
and trust companies so that it would also be applicable to national banks
in that State*
6JU Reg. Q, 1935, sec. IIJ(c)(5)j 193k BULLETIN 8X7#
-21*in which such offices were located* The Board did in fact prescribe
separate and higher rates for foreign branches of member banks in
certain countries; and the member banks complained that this action
made it difficult for them to compete with the local banks in those
countries*
The problem was resolved by the Banking Act of 193^5 which
made the provisions with respect to time and savings deposits, as
well as those relating to demand deposits, inapplicable to deposits
payable at offices of member banks outside the States of the United
States and the District of Columbia*
(B) DETERMINATION OF APPLICABLE MAXIMUM RATE
Prior to Jaiuary 1, 1936, there had been no problem in
determining the maximum rate of interest which could be paid on a
particular time deposit, for the simple reason that the maximum rate
was the same for all time and savings deposits^ After that date,
however, lAhen different maximum rates were prescribed for time deposits
according to different maturities, it sometimes became necessary to
determine ?vhich of the several maximum rates was applicable in a
particular case* The question arose principally with respect to
certificates of deposit of the kind heretofore mentioned "which made
provision for two or more alternate maturities and for the payment
of different rates of interest depending upon the withdrawal privilege
ultimately chosen by the depositor.
The Board had held at an early date that the applicable
maximum rate did not depend upon the length of time a deposit Y^ras left
in the bank* Thus, it ruled that a certificate payable upon 30 days1
notice could not provide for interest at one per cent if left for
30 days, 2 per cent if left on deposit 90 days, and 2-1/2 per cent if
left 6 months or longer#65 since such a certificate was at all times
payable after 30 days* notice the maximum rate payable under the
Supplement to Regulation Q was one per cent, regardless of the length
of time the deposit was left in the bank*
In the late 19^0!s competition led some member banks to
issue certificates providing for gradually increasing interest rates
the longer the funds were on deposit. One such certificate offered
one per cent if "withdrawn between 6 months and one year after deposit
upon 30 days1 notice, 1-l/ij. per cent if withdrawn during the second
year upon 90 days'notice, and so on, with the rate increasing each
65 1936 BULLETIN 51|8. Similarly, a certificate payable after 6 months'
notice, but providing that the bank might call the certificate for
payment at any time after giving 30 days1 notice to the depositor,was
held to be subject to the one per cent maximum rate# 1936 BULLETIN 1&9*
-25year until, if withdrawn at the end of 5 years after 6 months1 notice,
the deposit would bear 2-1/2 per cent interest for the full 5-year
period*
The Board held that in the case of such a certificate the
maximum interest rate payable would depend upon which of the several
withdrawal privileges might be elected by the depositor and upon the
rate applicable under Regulation Q to the particular withdrawal
privilege so elected. Thus-, if the certificate provided a stated
maturity of 5 years after date with interest at 2-1/2 per cent but
permitted withdrawal before that date after 90 days! notice with interest at 2 pe.f cent, the certificate was regarded as complying with
the requirements of the Regulation*66 I n 0ther words, however long
the deposit was left with the bank, interest £pu]d^ be paid at gradually
increasing rates if the rate paid upon actual withdrawal was within
the specified maximum rate for withdrawals after the period of notice
required and given as to that particular withdrawal,, 67
(C) COMPUTATION OF INTEREST
"When first issued in 1933* Regulation Q provided that the
rate of interest paid on a time or savings deposit should not exceed
the then specified rate of 3 per cent per annum, compounded semiannually, regardless of the basis upon which the interest was computed
by The bankj but the bank was not prevented from compounding interest
at other than semiannual intervals provided the aggregate amount of
interest paid did not exceed the amount which would be payable at a
rate of 3 per cent compounded semiannually*68 j n 193 c; the Board amended
the Regulation to provide for determination of the maximum rate on the
basis of compounding interest quarterly rather than semiannually, but
again it was made clear that member banks were free to compound interest
on any other basis provided only that the interest paid v/ould not exceed
the amount which would be payable if compounded on a quarterly basis,69
Originally, the Board held that interest could not be
computed in such manner as to cover any days prior to the date of
deposit or after the date of withdrawal, unless the rate vwas less than
the prescribed maximum so that the amount of interest paid for tthe period
during which the deposit was actually in the bank would not exceed the
66 1953 BULLETIN 721
67 The sanB p r i n c i p l e was applied t o "time d e p o s i t s , opaa account"
as well as t o time c e r t i f i c a t e s of deposit, 1953 BULLETIN 1050»
68 Reg* Q, sec. 111(c)(1) and V ( c ) ( l ) , and footnotes 6 and 9l
1933 BULLETIN 573, 57U
69
Reg. Q, 1935 j 193k BULLETIN 817,818
-26maximum rate,70 However, in its 1935 revision of Regulation Q the
Board expressly permitted interest to be paid, even at the maximum
rate, from the first day of any calendar month on a time or savings
deposit received during the first 5 days of such month*71 iVhen the
Regulation was again revised effective January 1, 1936, the "grace
period" allowed as to time deposits was omitted but ras continued in
the case of savings deposits*72 Still later, the allowance for savings
deposits was further liberalized. By a specific amendment to the
Regulation effective July 1, 1952, member banks were permitted, not
only to compute interest from the first day of any calendar month on
deposits received during the first 5 business days of such month, but
also to pay interest at the maximum rate from the first day of a calendar
month commencing a regular quarterly or semiannual interest period on
any savings deposit received during the first 10 business days of such
month and to pay interest at the maximum rate until the end of a month
ending such a quarterly or semiannual period on a savings deposit withdrawn during the last three business days of such month.73
In connection with the renewal of time certificates a
computation problem arose, not because of a possiblity of exceeding
the maximum rate, but because of the rule that atime deposit immediately upon its maturity becomes a demand deposit on which, of course,
no interest at all may be paid, At first, the Board held that, where
a time certificate was renewed after its original maturity date, no
interest could be paid for the period intervening between such original
maturity date and the date of renewal,ih Later, however, this position
was modified so as to permit member banks to pay interest covering the
intervening period provided the certificate was renewed within 10 days
after the original maturity date.75
70 1933 BULLETIN 652, However, the Board did go so far as to permit
computation of interest from the first day of a calendar month, where
that day was a Sunday or holiday, on a deposit received on the first
business day of such month, 193k BULLETIN 30iu
71 Reg. Q, 1935; sees. III(c)(U) and V(c)(ii)j 193h BULLETIN 817, 8l80
72 Reg. Q, 1936, sec, 3(d)j 1935 BULLETIN 86lu
73 Reg. Q, 1936, sec. 3(d); 1952 BULLETIN 650,
Ih 193k BULLETIN 6C9» The Board had previously held that interest
could not be paid for the intervening period even though the renewal
certificate was dated back to the original maturity date* 1933
BULLETIN 707a
75 1936 BULLETIN 1*19.
-27VII.
WITHDRAWAL RESTRICTIONS
(A) PARENT OF TIME DEPOSITS BEFORE MATURITY
It has been noted that, by definition, a deposit cannot
qualify as a time deposit unless it is payable at a specified date not
less than 30 days after the date of deposit or unless it is payable
after not less than 30 days1 written notice which iiust actually be
given in the event of withdrawal. It has also been noted that a
deposit will not meet the definition of a savings deposit unless it is
subject to an agreement under which the bank reserves the right (though
it need not be exercised) to require not less than 30 days1 notice in
writing before any withdrawal is made. In addition to these definitive requirements relating to withdrawals, the law imposes special
restrictions on the payment of both time and savings deposits.
The Banking Act of 1933 provided that ffno member bank shall
pay any time deposit before its maturity." Wo exceptions were made;
and the Board1s 1933 Regulation Q merely spelled out the statutory
prohibition, making it clear that therprohibition applied even though
no interest was paid on the deposit.'b
By 1935* however, it appears to have been generally agreed
that the absolute prohibition against payment of time deposits before
maturity should be relaxed.7"7 Accordingly, the Banking Act of 1935
amended the provision to permit payment before maturity upon such
conditions and in accordance with such rules and regulations as the
Board might prescribe.
Pursuant to this change in law the Board, In its 1936
revision of Regulation Q^9 permitted meraber banks to pay a time deposit
before its maturity but only "ir\ an emergency when it is necessary to
prevent great hardship to the depositor", and then only if the
76 Regulation Q, 1933, sec. IV j 1933 BULLETIN 573. The Board by
interpretation held the prohibition inapplicable in one exceptional
type of case: where a member bank, to prevent its closing, had
entered into a deferred payment agreement with its depositors and
later found itself in a position to make payment before the date
specified. 1934 BULLETIN 244.
77 See Conference Report, Aug. 17, 1935, Rep. No. 1822, p. 45.
78 49 Stat. 7 H .
79 Beg. Q, 1936, sec 4; 1935 BULLETIN 865.
-28depositor's application fully describing the circumstances is
certified by an officer of the bank. Moreover, upon any such payment
before maturity the depositor was required to forfeit all accrued and
unpaid interest on the deposit for a period of not Jess than three
months. Recognizing that a depositor could circumvent the Regulation
merely by borrowing from the bank on the security of his time deposit,
the Regulation farther provided that, while a member bank could make
such a loan, the rate of interest charged on the loan must be not less
than 2 per cent higher than the rate of interest payable on the deposit.
(B) WAIVING NOTICE OF WITHDRAWAL OF SAVINGS DEPOSITS
As has previously been indicated, a "savings deposit" must
be subject to an agreement under which the bank reserves the right to
require at least 30 days1 notice of withdrawal, but member banks need
not exercise that right and, as a matter of practice, seldom require
notice before withdrawal of savings deposits.
In the event, however, that a member bank should decide to
exercise its right to require advance notice of withdrawal of savings
deposits, it would be prohibited by specific provisions of the law
from waiving any such requirement of notice in paying any savings
deposit "except as to all savings deposits having the same requirement."
Presumably, this provision was designed to provide equal treatment for
all savings depositors.
BO The Board has published only a few interpretations of the provisions of the Regulation regarding payment before maturity. It has
held that a certificate maturing on a Sunday might be renewed prior to
maturity provided the renewal certificate was dated as of the date of
maturity of the original certificate, but that, if not renewed, the
certificate could not be paid on Saturday where State law provided
that an instrument maturing on Sunday should become due on the next
business day. 1939 BULLETIN 850. "Where a time deposit calling for
30 days1 notice and bearing interest at one per cent was amended to
provide for 90 days1 notice and interest at 1-1/4. per cent, the Board
ruled that there was no payment before maturity. 1951 BULLETIN 19.
Finally, in the case of a loan made on the security of a time certificate having a stated maturity but permitting earlier withdrawal
after 90 days1 notice, with the rate of interest dependent upon the
'withdrawal privilege actually exercised, the Board held that the loan
should bear interest at a rate not less than 2 per cent higher than
the rate of interest which the depositor would receive if he should
elect to withdraw the deposit at the time of the maturity of the loan.
1953 BULLETIN 950.
-29In its 1933 Regulation Q, the Board elaborated on the
statutory prohibition. The Regulation provideddi that, if a member
bank waived notice as to any ffportion or percentage" of the savings
deposit of one depositor, it should also waive notice as to the same
portion or percentage of the deposits of every other depositor subject
to the same requirement; and that, conversely, if the bank required
notice before payment of any portion or percentage of the deposit of
one depositor, it should require the same notice before paying the same
portion or percentage of the deposits of all other depositors subject
to the same requirement* In addition, a bank was required to observe
certain requirements before it made any change in its practice in
requiring or waiving notice of withdrawal.
These detailed regulatory provisions never proved to be of
any great significance, presumably because the banking situation improved after 1933, and there was consequently no need for banks to
exert their right to require advance notice before payment of savings
deposits.
Only once was the Eoard called upon to interpret these
provisions of the Regulation. Late in 1933 it held that the word
"portion", which appeared several times in the Regulation, should be
construed as including a specified amount, so that a member bank waiving notice as to a certain amount of the deposit of one depositor
would be obliged to pay the same amount, without notice, of the deposit of any other depositor subject to the same requirement.^
When Regulation Q was revised following the Banking Act
of 19359 the provisions regarding waiver of notice of withdrawal of
savings deposits were changed in only a few minor respects. ^ Conforming to the interpretation above mentioned, the word "portion" was
changed to "amount". It was provided that, if a bank should follow
the practice of requiring notice before withdrawal, the rate of interest
charged on any loan made on the security of a savings deposit should be
not less than 2 per cent higher than the rate of interest paid on the
deposit. This was in conformity with the similar requirement made by
the revised Regulation with respect to loans on time deposits.
81 Reg. Q, 1933, sec. VI; 1933 BULLETIN 574..
82 1933 BULLETIN 768.
83 Reg. Q, 1936, sec. 5} 1935 BULLETIN 865.
-30VIII.
EXCEPTIONS FROM THE STATUTE
As originally enacted in 193.3, the prohibition against the
payment of j.nterest on demand deposits was maae subject to four specific
exceptions. It did not apply (1) to the payment of interest in accordance with any
deposit contract which had been entered into in good faith
before the passage of the Banking Act of 1933;
(2) to any deposit of a member bank which was payable
only at an office located in a foreign, countryj
(3) to any deposit made in a member bank by a
mutual savings bank; or
(4) to any deposit of "public funds" made in a
member bank by any State, county, school district, or
other subdivision or municipality, if interest was
required to be paid on such deposit under State law.
The first exception - that with respect to previously made
contracts - was obviously desirable. However, the law made it clear
that no such contract could be renewed or extended unless modified to
conform to the law and that a member bank should take such action as
might be necessary to conform to the law as soon as possible "consistently with its contractual obligations."
The exception as to deposits payable only at an office located
in a foreign country was apparently intended to enable member banks
with foreign branches to compete on equal terms with the foreign banks
in the countries in which the branches were located. Moreover, the
motivating reasons behind the prohibition of interest on demand deposits
were not applicable to demand deposits received at an office in a
foreign country. Subsequently, the scope of the exception was broadened
by the Banking Act of 1935 to extend to deposits received at any
offices of member banks "located outside of the States of the United
States and the District of Columbia,"
The purpose of the third exception with respect to demand
deposits of mutual savings banks is not entirely clear. ^ It was
repealed by the Banking Act of 1935, subject to a "grace period" of
two years terminating August 23, 1937.
&i In construing this exception, the Board held that Massachusetts
cooperative banks and building and loan associations were not "mutual
savings banks" and that interest could not be paid, therefore, on
demand deposits made in member banks by such institutions. 1933
BULLETIN 563j 1933 BULLETIN 653.
-31The final exception was presumably made in order to give
recognition to the laws of some States which expressly required
payment of interest on demand .deposits made by the State Governments
and their instrumentalities.8^ However, when the interest-on-deposit
provisions were being reconsidered in Congress in 19359 it was apparently
felt that this exception, like the one with respect to mutual savings
banks, was not actually warranted. In the Banking Act of 1935 these
two exceptions were permitted to continue for only two more years,
until August 23, 1937. After that date, member banks were prohibited
from paying interest on demand deposits of public funds of States and
municipalities.
It should be noted that the payment of interest on demand
deposits of funds of the Federal Government was never excepted from
the statutory prohibition. However, there were some Federal statutes
which required interest on deposits of certain Government funds; and,
in order to eliminate this conflict, the Banking Act of 1935 expressly
provided that any such statutes should be deemed to be repealed to the
extent that they were inconsistent with the prohbition against the
payment of interest by member banks on demand deposits.So
in 1933 the Board had ruled that demand deposits of trust
funds made by the trust department of a member bank in its commercial
department were subject to the statutory prohibition.
Subsequently,
however, the Banking Act of 1935 put demand deposits of trust funds in
the same category as deposits of public funds, permitting interest to
be paid on such deposits if required by State law, but only until
August 23, 1937.
Accordingly, since August 23, 1937, the only demand deposits
in member banks which have been permitted to bear interest have been
deposits received at offices outside the United States and deposits
made in accordance with contracts executed prior to June 16, 1933, and
the latter exception is, of course, no longer of any great significance.
85 The Board construed this exception as applying to deposits of
public funds even though the State law requiring interest was enacted
after the passage of the Banking Act of 1933. 1933 BULLETIN 500.
However, the Board held that a municipal ordinance was not a "State
law" within the meaning of the exception (1934 BULLETIN 121), and that
deposits of moneys paid into a State court pending the outcome of
litigation were not deposits of "public funds". 1933 BULLETIN 500.
86 See 1937 BULLETIN 113.
87
1933 BULLETIN 568.
-32The provisions of the law directing the Board to limit the
rate of interest payable by member banks on time and savings deposits,
as originally enacted in 1933j contained no exceptions. However, in
exercising the discretion given it by the statute, the Board by
regulation allowed an exception with respect to contracts entered
into in good faith prior to the adoption by the Board of each change
in the maximum rates, so that deposits bearing a higher rate under
such contracts could continue to bear such higher rate unless and until
the contracts would be terminated or modified without legal liability.
Thus, the Board applied to time and savings deposits the principle of
the statutory exception with respect to the payment of interest on
demand deposits in accordance with prior contracts.
The Banking Act of 1935 amended the law to make the
limitations on the rate of interest payable on time and savings
deposits inapplicable to deposits received at offices of member banks
located outside the States of the United States and the District of
Columbia, At the same time the statutory prohibition against payment
of time deposits before maturity was relaxed to permit such exceptions
as might be allowed under regulations prescribed by the Board, These
matters have been considered in an earlier section.
@FedFRASER