House Committee Approves Interest on Business Checking

April 27, 2005

H.R. 1224, the Business Checking Freedom Act of 2005

Introduced on March 10, by Committee Vice Chair and Oversight and Investigations Subcommittee Chairwoman Sue W. Kelly (NY), the legislation would remove the prohibition on banks from paying interest on business checking accounts and would allow the Federal Reserve to pay interest on sterile reserves.

Rep. Kelly said, “The Business Checking Freedom Act will repeal an unfair, outdated law that is standing between our local small businesses and their ability to earn interest on their own money. By allowing banks to pay interest on business checking accounts, we create a new and broader market option that helps our main street banks and small businesses at the same time.”

Small-business owners are disadvantaged by the current ban on business checking because they tend to bank at smaller institutions. If they choose to bank at larger institutions, their smaller deposits typically mean they won’t qualify for complicated mechanisms such as sweep accounts. Larger banks offer these products, which circumvent the ban on interest-bearing checking accounts, to larger business depositors. Smaller institutions are often unable to offer such products.

Regarding interest on sterile reserves, the Federal Reserve requires banks, thrifts, and credit unions to maintain cash reserves to cover potential withdrawals and to help the Fed manage the nation’s monetary supply. No interest is paid to depository institutions on these funds. The payment of interest on banking reserves would provide incentives for financial institutions to increase their reserve balances voluntarily. In recent years, these balances have been dropping, holding potential consequences for the Fed’s ability to conduct monetary policy.

Rep. Oxley (OH) said, “In the competitive financial marketplace, no one should have the free use of someone else’s money. Individual consumers pay interest when they take out a car loan, home loan, or student loan. And yet, the government wants its loans for free -- it requires loans of reserves and doesn’t pay a penny of interest. Our government has always taken this privilege with other people’s money, but the free ride should end.”

A manager’s amendment, offered by Rep. Oxley, contains a compromise that would address the authority of industrial loan companies (ILCs) to offer interest-bearing accounts to their business customers. The amendment would specify that an ILC which obtained deposit insurance prior to October 1, 2003, would be authorized to pay interest on a business account, provided the ILC was owned by the same parent company that owned it as of that date. Other ILCs could also offer such interest-bearing accounts, provided that at least 85 percent of the gross revenues of their parent company and other affiliates were derived from activities that were financial in nature or incidental to a financial activity during at least three of the prior four calendar quarters. Additionally, the amendment would clarify that Federal regulatory interpretation regarding the treatment of benefits received by holders of certain escrow accounts would continue to apply.

An amendment, offered by Ranking Member Barney Frank (MA), would add bounced-check protection and overdraft-protection programs to the current list of retail banking services and products, which must be included in annual reports to Congress on fees charged by financial institutions.

Similar legislation cosponsored by Rep. Kelly was approved by the House in the last two Congresses.

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