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FRBSF

WEEKLY LETTER

December 28, 1984

New limits For The N.ew Year
The New Year will bring yet one more chapter in
the ongoing saga of deposit interest rate deregulation. On January 1, 1985, the regulatory minimum
balances on money market deposit accounts,
Super-NOW accounts and 7- to 31-day ceilingfree time accounts will decline to $1,000 from
$2,500. Only one year later, in 1986, all size
limitations on these accounts will be removed.
The lowering of the regulatory minimums forthese
accounts harbors the potential for inducing shifts
among financial assets that could distort the monetary aggregates, particularly M1 and M2. DepositOrs might choose, for example, to move funds
from regular savings deposit accounts, not included in M1, to Super-NOWs, included in M1,
which require lower balances. Such transfers
would temporarily boost M1 growth and thereby
make it more difficultto interpretthe behavior of
that aggregate. (There also is the question, not
addressed directly in this Letter, of whether the
greater flexibility afforded depository institutions
to pay explicit interest on liquid accounts could
affect the behavior of the monetary aggregates on
a more lasting basis.)
Central to whether the potential for the upcoming
regulatory changes to affect the monetary aggregates is of any practical importance is the vigor
with which depository institutions promote the
smaller accounts. Also of crucial importance is the
degree to which existing regulatory size limitations have been binding constraints. This Weekly
Letter looks at how commercial banks and thrifts
are approaching the upcoming regulatory
changes and whether the $2,500 limit has significantly deterred the shifting of funds to deregulated
accounts. This Letter ends with a discussion of
some factors that might be contributing to the
continued survival of fixed-ceiling accounts.

Background
In late 1982 and early 1983, commercial banks
and thrift institutions embraced the introduction of
two new deregulated accounts-Money Market
Deposit Accounts (MMDAs) and Super-NOWswith great zeal. They competed aggressively for
funds by offering extremely attractive interest
rates, particularly on the MMDA. The period of

intense competition for the deregulated accounts,
however, was relatively short-lived. For example,
the average rate on MMDAs at commercial banks
was above rates on short-term Treasury securities
only through April 1983. From April 1983 to October of this year, the average return on MMDAs
remained below short-term Treasury rates. Moreover, following the initial surge, interest rates on
the liquid deregulated accounts have tended to lag
behind movements in open market rates. As Chart
1 suggests, de'pository institutions tended to allow
the gap between the rates on short-term nondeposit instruments and the rates on MMDAs, and
especially Super-NOWs, to widen considerably
as interest rates rose in 1984. In the latter part of
1984, interest rates on MMDAs and Super-NOWs
also lagged behind the sharp decline in open market rates.
The observation that rates on MMDAs generally
are below open market rates should not be surprising given the high cost of attracting and maintaining retail-type deposits. The increase in the
gap between deposit and market rates when open
market rates rise probably reflects some reluctance on the part of investors to incur the costs and
inconvenience of transferring funds. When open
market rates decline, depository institutions are
slow to adjust their deposit rates downward probably out ofthe concern that they would jeopardize
relationships with depositors that are costly to
re-establish.

Proceeding with caution
Whatever factors are determining the pricing of
MMDAs and Super-NOWs, it is unlikely that the
change in minimum size will do much to alter the
competitive environment for commercial banks
and thrifts. Depository institutions in general are
not going to take bold marketing steps, such as
enticing depositors to open small deregulated accounts by offering relatively high promotional
rates. On the contrary, most depository institutions
are approaching the lowering of the minimum
average balances very cautiously.
The caution on the part of banks and thrifts is
reflected in the results of a survey conducted by
Trans Data Corporation (a private survey firm).

FRBSF
That survey found that in the third quarter of this
year, about half of the sampled institutions had not
made final plans on whether to lower the size
limits on either MMDAs or Super-NOWs. The
same survey found that only one-third of the sampled institutions had definite plans to lower the
limits. Moreover, for institutions that plan to lower
the! imits;feesand the tiering of interestrates; or
perhaps some combination of the two, wi II hold
down yields on the smaller accounts.
Responses to more recent inquiries of western
depository institutions by the staff of the Federal
Reserve Bank of San Francisco reinforce the findings ofTrans Data Corporation. Some commercial
banks and thrift institutions have decided to lower
the minimum average sizes on both MMDAs and
Super-NOWs, while others will reduce the size
limit for only one of the accounts. Many depository institutions, however, are claiming a "waitand-see" attitude.

Sizing it up

actions deposits between Super-NOWs and regular NOWs was influenced by factors other than
minimum deposit requirements.
If the lower minimum average balances were to
boostthe amountof Ml balances the public wanted to hold, the increase would most likely come
from the shifting of savings balances to SuperNOWs. Such shifts, of course, would be mitigated
by the simultaneous lowering of the regulatory
size limit of MMDAs. Indeed, since interest rates
on smaller size personal MMDAs cou Id be expected to be higher than those on comparable SuperNOWs (because the former are not subject to
reserve requirements), it would seem at least as
likely that Ml balances would be attracted to
MMDAs, and thereby depress M1. In fact, the
experience with the introduction of these deregulated accounts some two years ago showed that
flows to Super-NOWs from outside M1 were
about offset by shifts out of M1 to MMDAs.

More direct evidence also seems to support the
view that size limits have not been significant
barriers. Balances in Super-NOWs, for example,
generally are much higher than the current $2,500
minimums. Data available from the Trans Data
Corporation show that the median size of SuperNOWs is an estimated $13,000.

Even without competition from MMDAs, smaller
size Super-NOWs might not have much impact on
savers' decisions. The $2,500 size limit may be as
meaningless a deterrent to the shifting of savings
balances as it was to the shifting of transactions
balances. Just prior to the introduction of the
Super-NOW and MMDA, the savings component
in the monetary aggregates stood at about $360
bi II ion. Close to $310 bi II ion ofthattotal represented fixed-ceiling savings deposits. It is estimated, based on sample data, that approximately
80 percent of these fixed-ceiling deposits were in
accounts with balances in excess of $2,500. Since
1982, fixe9-cei ling savi ngs deposits have fallen by
over $60 bi II ion. While a sizeable drop, the persistence of a considerable volume of savings balances in relatively large, fixed-ceiling accounts suggests thatthe regu latory size Iimit has not been the
primary barrier preventing the remaining savings
balances from shifting to Super-NOWs, or even
MMDAs for that mat):er.

After the introduction of Super-NOWs, the average size of regular NOW account balances fell
about $700, indicating that large regular NOWs
had been an important source of the transfer of
funds among the components of M1. However,
with the average balance in regular NOWs at
commercial banks still averaging close to $5000
-twice the current minimum for Super-NOWsit seems clear that depositors' allocations of trans-

The potential of the lower size limits on thederegulated accounts for affecting M2 seems nonexistent. When MMDAs were introduced, M2 was
distorted by flows from large time deposit accounts ($100,000 or more), institution-only
money market mutual funds, and other market
instruments. However, these non-M2 outlets
shou Id not be affected by the lowering of the
minimum size for MMDAs. Consequently, the

In the absence of aggressive promotions by banks
and thrifts, the extent of the shifts and the sources
of the transfers to MMDAs and Super-NOWs will
probably be determined by the degree to which
the current limits represent meaningful barriers to
savers. Th is does not mean that the level of promotion is independent of whether the lim its are bi nding. In fact, the lack of vigor on the part of depository institutions in pursuing the imminent regulatory changes can be interpreted as an indication
that the $2,500 minimum balances for MMDAs
and Super-NOWs have not had much impact on
depositors' choices of accounts.

Chn,I2
T·6111 R811l8nd
Cost 01 Savings Doposll.

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lower minimum on the MMDA should not attract
a measurable amount of funds from outside M2.

holders of the bulk of savings deposits have not
had to cover these higher costs. For these savers,

More that meets the eye
If account size has not been a significant barrier to
the popularity of deposit accounts with marketrelated rates of return, how do we explain the
continued survival of $250 billion in savings, $80
billion in personal demand deposits, and $100
billion in other personal checking accounts excluding 5uper-NOWs, all of which pay zero or
comparatively low fixed rates of interest? Some
might argue that lack of information or inertia
accounts for the failure of more depositors to shift
funds to MMDAs and Super-NOWS. However,
the decision of some depositors to remain in fixedceiling accounts may be based on other, more
tangible, reasons.

of explicit and implicit interest-has risen by
far more than that suggested by the fixed-rate
ceilings.

the overall return-that is, the combination

One likely reason for the continued attractiveness
of personal demand deposits and regular NOWs is
the imposition of fees on Super-NOWs. These fees
are usually waived only for larger accounts,
whereas fees on regular NOWs often are waived
for even modest-sized accounts.
By remaining in fixed-ceiling accounts, depositors
also may accomplish more than merely avoid
fees. Take savings deposit accounts, for example.
Over the years, as market interest rates have risen,
balances in savings deposits, of course, have declined. The balances that have remained, however, are different in nature from those that have
been shifted to other accounts. In particular, the
surviving savings deposits are more active on average. Annual deposit turnover rates for savings
deposits have increased from 1% to over 5 between 1977 and 1984. Since more active accounts
are more expensive to maintain, institutions have
moved to impose fees on smaller savings deposits.
While such fees could affect a large number of
accounts, they have no impact on the vast majority of deposits because they generally are waived
for all but the smallest accounts. Consequently,

Chart 2 shows estimates of the implicit interest
(noninterest expenses less fees as a percent of
savings deposits) for savings deposits based on
Fu nctional Cost Analysis data. Wh i1e an imperfect
proxy for the implicit return on deposits, the data
prOVide some perspective on the gro.wing importance of implicit interest in the overall returns of
savings deposits at commercial banks. As the chart
suggests, the combined expl icit (passbook rate) and
implicit (noninterest expenses) return on savings
may be what makes such holdings sufficiently
attractive for some depositors. The attractiveness
of implicit interest for personal deposits is understandable, even in a deregulated environment,
because it is tax free.

Conclusion
On January 1, the regulatory minimum average
balances on MMDAs, Super-NOWs, and 7- to
31-day accounts will be set at $1,000. The lower
denomination accounts will be available to depositors, but the extent of their appeal remains
uncertain. Most depository institutions do not plan
to promote the smaller accounts very aggressively.
Moreover, it does not appear that the higher size
limits have been responsible for the bulk of the
funds remaining in fixed-cei ling deposit accounts.
The evidence on the effect of size limits on where
depositors decide to place their funds indicates
that the lower size limits will not seriously distort
M1 orM2 in 1985 as a whole. To the extent thatthe
monetary aggregates might be affected, past experience indicates that the impact would be concentrated in the first few months of next year.

Frederick T. Furlong

Opinions expressed in this newsletter do not necessarily renect the views of the management of the Federal Reserve Bank of San
francisco, or of the Board of Governors of the Federal Reserve System.
E~itorial comments may be addressed to the editor (Gregory Tong) or to the author .... Free copies of Federal Reserve publications
can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974·2246.

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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)

Selected Assets and Liabilities
Large Commercial Banks
Loans, Leases and Investments 1 2
Loans and Leases 1 6
Commercial and Industrial
Real estate
Loans to Individuals
Leases
U.S. Treasury and Agency Securities 2
Other Securities2
Total Deposits
Demand Deposits
Demand Deposits Adjusted 3
Other Transaction Balances4
Total Non-Transaction Balances6
Money Market Deposit
Accounts-Total
Time Deposits in Amounts of
$100,000 or more
Other Liabilities for Borrowed MoneyS

Two Week Averages
of Daily Figures

Change from 12/28/83
Dollar
Percent?

Amount
Outstanding

Change
from

12/12/84

11/05/84

188,103
169,529
53,111
61,643
31,416
5,079
11,524
7,050
192,358
44,943
29,434
12,668
134,748

632
695
300
79
204
4
81
17
-2,170
-2,024
-1,276
- 397
253

12,078
14,174
7,148
2,744
4,765
16
983
1,113
1;361
- 4,294
1,897
107
5,763

7.1
9.4
16.1
4.8
18.5
0.3
8.1
- 14.1
0.7
9.0
6.2
- 0.8
4.6

40,683

177

1,086

2.8

40,668
21,661

-

244
639

-

Period ended

Period ended

12/03/84

2,503
1,346

11/19/84

Reserve Position, All Reporting Banks
Excess Reserves ( + )/Deficiency (- )
Borrowings
Net free reserves (+ )/Net borrowed( -)

65
51
13

18
21
2

1 Includes loss reserves, unearned income, excludes interbank loans
2

Excludes trading account securities·

3 Excludes U.S. government and depository institution deposits and cash items
4 ATS, NOW, Super NOW and savings accounts with telephone transfers

S Includes borrowing via FRB, TI&L notes, Fed Funds, RPs and other sources
6 Includes items not shown separately
7

Annualized percent change

-

6.8
6.0