On July 21, a banking regulation on the books for nearly a century and considered by many to be one of the most antiquated laws will finally be repealed. That’s the date when Reg Q, which has prohibited banks from paying interest on commercial demand deposit accounts since the Great Depression, will officially become part of the history books.
The repeal of Req Q comes courtesy of the Dodd-Frank financial reform bill passed last summer. The big question now is what will be the impact of this repeal on community banks?
Predictions from the pundits run the gamut, from a “non-event” to a “game-changer.” In a recent article published in Treasury & Risk magazine, the treasurer at cash-rich Microsoft said the repeal of Reg Q will not change the way the software giant manages its cash. The VP of finance at another big West Coast tech firm, however, said he does expect his firm to change its cash management practices based on the repeal.
Of course, larger banks have gotten around the restrictions of Reg Q by offering alternatives like sweep accounts and account analysis. And most experts agree that in the current low-interest-rate environment, the initial impact may be muted. However, community banks should be planning their competitive strategies in light of Reg Q’s repeal now — instead of waiting until moves by competitors force their hand.
Community banks may be especially vulnerable to the impact of Reg Q’s repeal because they usually have
a larger percentage of relatively unsophisticated small business customers who keep balances in non-interest checking accounts. No-cost small business deposits are also a core funding vehicle for many, if not most, community banks.
Offense or Defense?
Community banks can essentially play offense or defense in response to the repeal of Reg Q:
Offense: The offensive position is simply to begin paying interest on commercial deposits right out of the gate. This will not only help you retain existing deposits, but it may also help you take balances away from competitors that decide not to pay interest.
You could start out by paying interest on larger balances only, since losing them would hurt the most. Doing so might also encourage borrowers to consolidate balances held in other banks with you in order to earn interest. The idea is to preserve your best customer relationships without cannibalizing your deposit base.
Defense: The defensive position is to not pay interest on commercial deposits, at least not right away. You may eventually be forced by competitors to start paying interest, but with rates so low, you could hold onto most if not all of your small business deposits in the short run.
Playing defense could be dangerous, however. You don’t want to suddenly discover one day that your deposit balances have dropped sharply as small business customers have switched to your competitors who are paying interest. At this point, the proverbial barn door will already be open — and your horses escaped.
Therefore, a modified defensive position may be the best course of action if you decide you don’t want to play an aggressive offensive game.
This would involve a two-step process:
1. Perform an analysis of your entire deposit base to determine what percentage consists of non-interest small business accounts. This will help determine the potential cost and magnitude of paying interest on these accounts.
2. Monitor your competitive environment and your deposit base carefully. Keep an eye on what your competitors are doing in response to the repeal, and watch for any signs of depletion in your deposit base. If you do see that it is dropping more than you would normally expect, be prepared to act quickly in response to these competitive pressures.
The Floodgates Open
One more thought: A wise old banker once told his young understudy that if an action is in the best interest of his customer but he didn’t take that action, his competitor surely would — and his customer wouldn’t forget it.
With Reg Q soon to be history, most experts anticipate that all banks will eventually end up paying interest on commercial deposits — it’s just a matter of time. Keep this in mind as you plan your competitive strategy in the post-Reg Q banking world.
Give us a call if you would like to discuss your Reg Q strategy in more detail.