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T-·-----------
Deposit Deregulation
Just a year ago, Congress passed the Depository Institutions Deregulation and Monetary
Control Act ( M CA)-a major step in the deregulation of financial institutions. Perhaps
the most important aspectofthis far-reaching
legislation was its call for the removal of legal
deposit-rate ceilings. As a first step, the Act
permitted nationwide interest-bearing checking (N OW) accounts, which most banks and
thrifts now offer at a 5%-percent ceiling rate.
More importantly, the landmark legislation
also mandated complete phaseout of all legally imposed deposit-rate ceilings by April
1986.
Today's legal ceilings stem from the Banking
Act of 1935, which prohibited payment of
explicit interest on demand deposits-and gave
regu latory agencies the authority to impose
rate ceilings on bank time and savings accounts. In 1966, Congress extended the regulatory authority to deposits at thrifts (savingsand-loan associations and mutual savings
banks). At present, rate ceilings apply to all
categories except large-denomination
sources of funds (such as certificates over
$1 00,000, Eurodollar deposits, repurchase
agreements, or other specialized borrowing
by banks and thrifts). Ceilings thus apply to 9-11
of the following:
• Passbook savings at 5% percent for banks
and (because of a required %-point ceiling
differential) 51f2percent for thrifts;
• Nongovernmental time accounts from 5%
percent to 7% percent at banks, depending .
on maturity (6 to 8 percent at thrifts because
of the differential);
• Governmental accounts of all maturities at
8 percent at both banks and thrifts;
• IRA and Keogh (retirement) accounts of
3-year maturity or more at 8 percent for both
banks and thrifts; and
• Special variable-ceiling accounts, such as
6-month "money market" and 2 Y2-yearot
more "small saver" certificates, for which the
ceilings move with rates on Treasury securities of comparable maturities-with a cap
on small-saver certificates of 11% percent at
banks and 12 percent at thrifts.
With the rise in open-market rates since the
late 1960's, the ceilings have acted to limit
funds flowing into depository institutions.
Regulatory agencies first responded to these
outflows by eliminating ceilings on openmarket sources of funds in the early 1970s.
But as outflows of consumer deposits accelerated, the regulators then created the
6-month and 2Y2-year variable-ceiling certificates, thereby allowi ng rates on such instruments to come closer to open-market rates.
Thus, the structure of deposit-rate ceilings
already became battered by the strains of
rising open-market rates well before passage
of the M CA.
MCA/DIDC
Throughout the 1970's, regulatory agencies
tended to respond to deposit outflows by
removing ceilings piecemeal under crisis
conditions-and also by permitting a slight
upward drift in the ceiling on passbook accounts (see chart). Congress finally developed the M CA to assure ultimate removal of
the ceilings. Because various institutions
would be affected in different ways by removal of deposit ceilings, the M CA called for
the creation of a Depository Institutions Deregulation Committee (DI DC), composed of
the Secretary of the Treasury; the chairmen of
the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Federal
Home Loan Bank Board, and the National
Credit Union Administration; and the Comptroller of the Cu rrency (a nonvoti ng member).
This group is charged with orchestrating a
plan for removing ceilings by April 1986. To
this end the Committee already has brought
the variable-rate ceilings on the "money
market" and "small-saver" certificates closer
to the effective open-market rates on comparable Treasury securities, and has requested comment on removing the cap on the
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market or the viability of the thrift industry."
This is indeed a major issue for the OI OC. The
S&L's and savings banks believe thatthey will
be badly hurt by the removal of ceilings-in
part because they have a disproportionate
(but rapidly waning) number of "interest
insensitive" savers, and in part because they
consider the %-point differential in the ceiling crucial for attracting deposits. Moreover,
the thrifts believe that without relief for the
asset side of their balance sheets, they simply
can't compete on the liability side.
small-saver certificate. But the larger task of
removing the multitude of fixed-rate ceilings
still lies ahead.
Optimistic "solution"
Obviously, the OI OC's task would be simplified ifthe inflation rate were to decline sign ificantly, bri ngi ng interest rates down in
tandem. Indeed the Committee already has
taken a step to render the variable-rate ceilings (and the thrift differential) ineffective in
an environment of low interest rates. Last
May it declared floors on the ceilings for
6-month and 2Y2-year certificates such that if
open-market rates were to fall below 71/4and
9112percent on comparable Treasury securities, respectively, the ceilings and the
%-point differential would no longer be
effective.
Both the National Savings and Loan League
and the U.s. League of Savings Associations
have expressed support for an orderly sixyear phaseout of ceilings. But both have also
expressed grave concerns about rapid removal.ln a petition to the OI OC, the National
S&L League recommended that the Committee allow financial institutions to offer "market rates" on the longest-maturity (8-year)
certificates first (by July 1 981 ) and work
progressively toward the shorter-maturity
accounts, finally arriving at removal of passbook ceilings in 1 986. Moreover, the League
defined "market rate" as a variable ceiling
tied to the Treasury security of appropriate
maturity plus thrift differential, thereby
implying a permanent role for the differential
ceiling. The U.S. League also has emphasized
maintenance of the differential during the sixyear phase out period and furthermore has
called for unanimity on all OI OC decisions,
which would give veto power to any voting
member of the Committee.
Inflation and interest rates would have to
drop very steeply, however, for rate ceilings
to become ineffective, either on these certificates or (especially) on passbook savings.
The gap between open-market interest rates
and the ceilings is just too great for that to
happen soon (see chart). Since the Committee cannot wait indefinitely, it will have to
develop a strategy for raising the ceilings.
a
Consensus
The OI OC faces a difficult task; it must reach
a consensus on a strategy that probably wi II
raise the average cost of funds for many institutions, and that will affect differently the
various institutions represented by the Committee's members. Such a consensus will not
come easily; indeed, the OI OC's plans could
yet be thwarted by legislative attempts to alter
the mandate of the M CA. Paul Horvitz (University of Houston) recently noted that the
. DI OC must develop a strategy that is "neither
so cautious that ceilings are still with us in
1 986, nor so bold or erratic that Congress
steps in to reverse the deregulation process."
In its most recent meeting (March 26), the
0'1D C responded by aski ng for comment on
two proposals: (1) removing the present 12
(11 %) percent cap on the variable ceiling for
small saver certificates, and (2) establishing
an overall approach for further deregulation.
This overall strategy would remove ceilings
on certificates with maturity of five years or
more on JuIy 1, 1 981 ; fou r to five years on
July 1, 1 982; two to four years on July 1,
1 983; one to two years on JuIy 1, 1 984; six
months to one year on July 1, 1 985. Remaining ceilings would then be eliminated on
The M CA requ i res each member of the 01D C .
to file an annual report regarding whether
removal of the bank-thrift differential wi II
" . . . adversely affect the housing finance
2
porations and institutions utilize, including
$1 00,000 CDs at depository institutions.
Thus, one can think of MMFs simply as vehicles for pooling deposit funds to circumvent
the antiquated ceilings.
April 1, 1 986, the legal deadline. If implemented, the plan would help to stretch out
the maturity structure of liabilities at depository institutions, which would be of particular
interest to thrifts in particular because of the
heavy concentration of their assets in longterm mortgage loans. Ifthis approach seemed
infeasible, the DI DCasked for comment on
an alternative approach proposed by its staff:
phase-in variable ceilings tied to appropriate
Treasury security rates during the five-year
period, which could mean the retention of
the thrift differential during the period.
The spiraling growth of MMFs suggeststhat
small depositors will not wait for a slow removal of ceilings. In response, the American
Bankers Association is seeking permission for
depository institutions to offer a new shortterm instrument to compete with the funds.
But some banks and thrifts are also pressing
Congress to place restrictions such as reserve
requirements and rate ceilings on the funds.
Consumer groups in the meantime are fighting to maintain the M M Fs and to remove
deposit ceilings as rapidly as possible.
Marketpressures
Market forces suggest that a slow phaseout of
rate ceilings could still result in a continued
flight of deposits. So long as open-market
interest rates remain near their present lofty
levels, a wide gap will persist between those
rates and the ceilings on short-term deposits.
Moreover, in the present environment of uncertainty about inflation, savers will view
long-term deposits as risky assets,just as they
do long-term bonds. Thus, rates on long-term
certificates will have to parallel the high rates
on bonds with comparable maturities if institutions hope to attract substantial amounts
into such instruments.
Market forces should not be discounted
among all the various pressures now existing
for more or less rapid removal of deposit rate
ceilings. Throughout the 1970's, a crisis of
deposit outflows preceded every decision to
lift ceilings. In the 1980's, despite some signs
of relief from presently high inflation and interest rates, consumers will seek market rates
on deposits regardless. So long as the M M Fs
and other ceiling-free short-term savings
vehicles exist-and such institutions would
be extremely d ifficu It to legislate away, given
the many forms that they cou Id takedeposits constrained by fixed ceilings will
continue to run off (and be replaced by C Ds
and other purchased funds). Whether by fiat
or fl ight, such fixed-rate deposits wi II become
a relic of the past.
The great popularity of money-market funds
(MMFs) can be explained largely by depositor
preferences to stay short and free of rate cei lings in an environment beset with inflation
risk. ( Other factors favoring M M Fs are investor liquidity and the convenience of withdrawing by check.) By pooling their funds in
an MM F, small depositors are able to access
the same short-term money markets that cor-'
JackBeebe
Percent
12
INTEREST RATES
10
91-day Treasury Bills
8
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6
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.
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Ceiling
(Bank)
2
1960
1965
1970
3
1975
1980
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\ill\£?cru
;)J\ill WID;)JJt\2?dI
(Dollaramountsin millions)
Loans(gross,adjusted)
andinvestments*
Loans(gross,adjusted)
- total#
Commercialandindustrial
Realestate
Loansto individuals
Securities
loans
U.s.Treasury
securities*
Othersecurities*
Demanddeposits- total#
Demanddeposits- adjusted
Savings
deposits- total
Timedeposits:-total#
Individuals,part.& corp.
(largenegotiable
CD's)
WeeklyAverages
of Daily Figures
MemberDankReserve
Position
Excess
ReserVes
(+ )/Deficiency(- )
Borrowings
Netfreereserves
(+)/Netborrowed(
-)
\0J\@CS
@AJr@<§@@
BANKINGDATA-TWELFTHFEDERAL
RESERVE
DISTRICT
SelectedAssetsandLiabilities
large CommercialDanks
Jr
Amount
Outstanding
3/25/81
146,737
124,199
36,288
51,395
23,372
1,388
6,803
15,735
39,278
28,420
30,224
76,233
67,267
29,342
Changefrom
yearago
Dollar
Percent
Change
from
3/18/81
97
- 201
- 353
77
27
21
35
69
-1,691
393
216
-1,01 9
952
- 562
5.8
6.5
7.0
13.2
- 4.5
38.4
0.9
2.3
- 5.8
- 6.4
10.8
24.0
27.5
34.2
8,020
7,612
2,386
6,002
1,105
107
61
347
- 2,436
1,956
2,944
14,761
14,522
7,477
-
Weekended
Weekended
3/25/81
3/18/81
n.a.
n.a.
139
30
n.a.
n.a.
Comparable
year-ago
period
-
0
198
198
* Excludes
tradingaccountsecurities.
# Includesitemsnotshownseparately.
Editorialcommentsmaybeaddressed
to theeditor(WilliamBurke)or to theauthor.••. Freecopiesof this
andotherFederalReserve
publications
canbeobtainedbycallingor writingthePublicInfonnationSection,
FederalReserve
Bankof SanFrancisco,
P.O.Dox7702,SanFrancisco
94120.Phone(415)544-2184.
@FedFRASER