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FEDER A L RESERVE BANK OF DALLAS
DALLAS, TEXAS 75222

Circular No. 70-163
July 13, 1970

INTERPRETATION ON PREPAYMENT OF INTEREST ON DEPOSITS
(Regulations D and Q)

To All Member Banks
in the Eleventh Federal Reserve District:
In view of the number of questions we have been receiving
on the subject of prepaid interest on deposits, we reproduce on the
reverse of this circular an interpretation of the Board of Governors
of the Federal Reserve System on this subject.

The interpretation

discusses this practice in the context of Regulation Q (interest on
,
Deposits) and Regulation D (Reserves of Member Banks).
Yours very truly,
P. E. Coldwell
President

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)

INTERPRETATION OF REGULATIONS Q AND D

PREPA Y M EN T OF INTEREST
ON DEPOSITS
The Board of Governors has considered the
status under Regulations Q and D of certificates of
deposit offered by a member bank with interest
paid at the time of issuance.
Under the plan considered by the Board, the
bank offers to prepay interest at the rate of 5
per cent per annum on a certificate of deposit in
an amount less than $100,000 with a single ma­
turity from two years to four years and eleven
months. In the event the deposit is paid before ma­
turity in accordance with § 217.4(d), relating to
payment in emergencies, the deposit contract
authorizes the bank to recoup from the principal
an amount sufficient to reduce the depositor’s yield
on his investment to no more than 5 3 per cent
A
on the funds withdrawn for the time such funds
are on deposit (the current maximum rate on
deposits of less than $100,000 with a maturity of
at least two years).
If interest were prepaid at the rate of 5 % per
cent per annum, the bank would violate Regula­
tion Q. In such a circumstance, the prepaid in­
terest could be reinvested with the member bank

and earn interest at the rate of 534 per cent. In
such event, the aggregate amount of the prepaid
interest plus interest thereon would exceed the
maximum amount the bank could have paid at
maturity of the certificate with interest computed
at the current maximum permissible rate on the
type of deposit involved ( 5 3 per cent).
A
Under the plan offered by the bank, the depos­
itor receives a yield on his investment in excess of
the amount of interest that a member bank may
pay under Regulation Q for one year on the type
of deposit involved. However, this consideration
is not determinative in view of the maturity of
the deposit. The significant consideration is
whether the amount of prepaid interest plus in­
terest thereon at the maximum rate that may be
paid on the type of deposit involved exceeds the
aggregate amount of interest that could have been
paid on the deposit at maturity computed at the
applicable maximum rate. Stated in another
manner, the amount the depositor receives at
maturity of the certificate may not exceed the
amount he actually places with the bank at the time
of issuance of the certificate (the face amount
less the amount of prepaid interest) plus 5 3 per
A
cent per annum on such amount for the life of
the deposit.
Based upon these considerations, the Board
concluded that the plan offered by the member
bank is consistent with the provisions of Regula­
tion Q. In view of § 217.6(f), relating to accuracy
of advertising, the bank should avoid, as with
respect to any other time deposit, any statement
that might mislead potential depositors into be­
lieving that they may withdraw their deposit at
any time before maturity with an appropriate
deduction to adjust the effective yield on the de­
posit.
In view of the form of the contract, reserves
should be maintained against the face amount of
the certificate in accordance with Part 204 (Reg­
ulation D ), without deduction for prepaid inter­
est. If the form of the contract were on a dis­
count basis so that the amount of the bank’s ob­
ligation to the depositor increases over the life
of the deposit, reserve requirements would ini­
tially apply only to the amount of funds received
for the certificate, just as in the case of a certificate
sold at the face amount with interest paid at
maturity.


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102