[House Hearing, 107 Congress]
[From the U.S. Government Printing Office]

                         FEDERAL RESERVE BANKS



                               BEFORE THE

                            SUBCOMMITTEE ON

                                 OF THE


                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION


                             MARCH 13, 2001


       Printed for the use of the Committee on Financial Services

                            Serial No. 107-4

71-148                     WASHINGTON : 2001

 For sale by the Superintendent of Documents, U.S. Government Printing 
 Internet: bookstore.gpo.gov Phone: (202) 512-1800 Fax: (202) 512-2550
               Mail: Stop SSOP, Washington DC 20402-0001


                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice      BARNEY FRANK, Massachusetts
    Chair                            PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska              MAXINE WATERS, California
RICHARD H. BAKER, Louisiana          CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama              LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware          NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma             KEN BENTSEN, Texas
ROBERT W. NEY, Ohio                  JAMES H. MALONEY, Connecticut
BOB BARR, Georgia                    DARLENE HOOLEY, Oregon
SUE W. KELLY, New York               JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                MAX SANDLIN, Texas
CHRISTOPHER COX, California          GREGORY W. MEEKS, New York
DAVE WELDON, Florida                 BARBARA LEE, California
JIM RYUN, Kansas                     FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama                   JAY INSLEE, Washington
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      CHARLES A. GONZALEZ, Texas
DOUG OSE, California                 STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois               MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin                HAROLD E. FORD Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania      RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut       KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York              JOSEPH CROWLEY, New York
GARY G. MILLER, California           WILLIAM LACY CLAY, Missouri
ERIC CANTOR, Virginia                STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York       MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania         

             Terry Haines, Chief Counsel and Staff Director
       Subcommittee on Financial Institutions and Consumer Credit

                   SPENCER BACHUS, Alabama, Chairman

DAVE WELDON, Florida, Vice Chairman  MAXINE WATERS, California
MARGE ROUKEMA, New Jersey            CAROLYN B. MALONEY, New York
DOUG BEREUTER, Nebraska              MELVIN L. WATT, North Carolina
RICHARD H. BAKER, Louisiana          GARY L. ACKERMAN, New York
MICHAEL N. CASTLE, Delaware          KEN BENTSEN, Texas
EDWARD R. ROYCE, California          BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma             MAX SANDLIN, Texas
BOB BARR, Georgia                    GREGORY W. MEEKS, New York
SUE W. KELLY, New York               LUIS V. GUTIERREZ, Illinois
PAUL E. GILLMOR, Ohio                FRANK MASCARA, Pennsylvania
JIM RYUN, Kansas                     DENNIS MOORE, Kansas
BOB RILEY, Alabama                   CHARLES A. GONZALEZ, Texas
STEVEN C. LaTOURETTE, Ohio           PAUL E. KANJORSKI, Pennsylvania
DONALD A. MANZULLO, Illinois         JAMES H. MALONEY, Connecticut
WALTER B. JONES, North Carolina      DARLENE HOOLEY, Oregon
JUDY BIGGERT, Illinois               JULIA CARSON, Indiana
PATRICK J. TOOMEY, Pennsylvania      BARBARA LEE, California
ERIC CANTOR, Virginia                HAROLD E. FORD, Jr., Tennessee
FELIX J. GRUCCI, Jr, New York        RUBEN HINOJOSA, Texas
MELISSA A. HART, Pennsylvania        KEN LUCAS, Kentucky
MIKE FERGUSON, New Jersey            JOSEPH CROWLEY, New York

                            C O N T E N T S

Hearing held on:
    March 13, 2001...............................................     1
    March 13, 2001...............................................    41

                        Tuesday, March 13, 2001

Bochnowski, David A., Chairman and Chief Executive Officer, 
  Peoples Bank, SB, Munster, IN, Chairman, America's Community 
  Bankers........................................................    26
Gulledge, Robert I., Chairman, President and Chief Executive 
  Citizens Bank, Inc., Robertsdale, AL, on behalf of the 
  Independent Community Bankers of America.......................    29
Hammond, Donald V., Acting Under Secretary for Domestic Finance, 
  Department of the Treasury.....................................     8
Jennings, Thomas P., Senior Vice President and General Counsel, 
  Virginia Banks, Inc., on behalf of The Financial Services 
  Roundtable.....................................................    28
Meyer, Hon. Laurence H., Member, Board of Governors, Federal 
  Reserve System.................................................     7
Smith, James E., Chairman and Chief Executive Officer, Citizens 
  Union State Bank and Trust, Clinton, MI, President-elect, 
  American Bankers Association...................................    25


Prepared statements:
    Bachus, Hon. Spencer.........................................    42
    Kelly, Hon. Sue..............................................    44
    Bochnowski, David A..........................................    69
    Gulledge, Robert I...........................................    80
    Hammond, Donald V............................................    56
    Jennings, Thomas P...........................................    75
    Meyer, Hon. Laurence H.......................................    45
    Smith, James E...............................................    60

              Additional Material Submitted for the Record

Association for Financial Professionals, prepared statement......    85
Independent Community Bankers, prepared statement................    92
National Federation of Independent Business, prepared statement..   130
U.S. Chamber of Commerce, prepared statement.....................   133



                        TUESDAY, MARCH 13, 2001

             U.S. House of Representatives,
            Subcommittee on Financial Institutions 
                               and Consumer Credit,
                           Committee on Financial Services,
                                                    Washington, DC.
    The subcommittee met, pursuant to call, at 2:10 p.m., in 
room 2128, Rayburn House Office Building, Hon. Spencer Bachus, 
[chairman of the subcommittee], presiding.
    Present: Chairman Bachus; Representatives Weldon, Bereuter, 
Lucas of Oklahoma, Kelly, Manzullo, Biggert, Toomey, Cantor, 
Hart, Capito, Ferguson, Rogers, Tiberi, Waters, Watt, Bentsen, 
Carson and Shows.
    Chairman Bachus. The hearing of the Subcommittee on 
Financial Institutions and Consumer Credit will come to order. 
Without objection, all Members' opening statements will be made 
a part of the record.
    I now am going to recognize myself for an opening 
statement, and then the subcommittee Chairs and Ranking Members 
will make opening statements, which will be limited to five 
minutes, and the other Members will be recognized for three 
minutes for opening statements.
    Today the subcommittee convenes to consider two separate 
but related proposals. One, repealing the current ban on the 
payment of interest on business checking accounts; and, two, 
permitting interest to be paid on funds that banks and other 
depository institutions are required by law to maintain at the 
Federal Reserve banks. The eyes of most Americans may glaze 
over at the mention of these two issues, yet both are of 
critical importance as the subcommittee seeks to continue the 
work of modernizing our financial system, which we began last 
year with the enactment of Gramm-Leach-Bliley.
    Like many of the provisions repealed by Gramm-Leach-Bliley, 
the ban on paying interest on business checking accounts is a 
Depression-era prohibition. Many think it has long since 
outlived its usefulness, and I myself have that opinion. When 
originally enacted in 1933, the ban was designed to protect 
small rural banks from having to compete for deposits with 
larger institutions based upon what they could offer customers 
as far as a higher interest rate. That was valid at one time. 
This policy justification is simply no longer relevant in a 
competitive environment where banks must compete not merely 
against each other, but against a host of non-bank financial 
firms offering a wide range of interest-bearing products.
    The prohibition on paying interest to business checking 
customers is one of the many factors contributing to a 
liquidity crunch for our Nation's small community banks. Faced 
in many cases with declining deposits coupled with strong 
demand for loans in their communities, small banks are caught 
in a vise, and are increasingly forced to seek funding from the 
Federal Home Loan Banking System and other alternative sources. 
Unable to earn interest on their checking account balances, 
small businesses in areas served by community banks have a 
powerful bottom-line incentive to take their business 
elsewhere. Not surprisingly, many choose to do exactly that, 
opening cash management accounts at brokerage firms or parking 
their assets in other interest-bearing vehicles outside the 
banking system.
    Repealing the ban on interest on business checking accounts 
will allow banks to compete for such deposits on a more level 
playing field and promote the development of bank products and 
services geared toward a corporate clientele that is ill-served 
by the current prohibition.
    The second issue we will address today is somewhat the flip 
side of the first issue. Under current law, depository 
institutions are required to hold deposits at the Federal 
Reserve banks against transaction accounts maintained by the 
institution's customers. No interest is paid on these reserves. 
Banks have argued, persuasively in my view, that if the law is 
changed to permit interest to be paid on business checking 
accounts, a corresponding change should be made to authorize 
payment of interest on reserves that banks are required, by 
law, to maintain at the Federal Reserve banks.
    In addition, as we will hear in a moment from Federal 
Reserve Governor Meyer, I would anticipate that he will testify 
that failure to act in this area not only disadvantages banks, 
but it may at some point begin to have adverse consequences on 
the Fed's ability to conduct its monetary policy.
    Last year, the House passed legislation that would have 
repealed the prohibition on interest payments on business 
checking accounts, but the bill died in the Senate. Similarly, 
this subcommittee favorably reported legislation to authorize 
the Federal Reserve to pay interest on statutorily required 
reserves, but the full House never took up the bill. Two 
respected Members of this subcommittee, Mrs. Kelly and Mr. 
Toomey, have taken the lead this year in reintroducing these 
important proposals. I look forward to working with them and 
with Chairman Oxley to make sure that this Congress succeeds 
where past efforts have failed.
    [The prepared statement of Hon. Spencer Bachus can be found 
on page 42 in the appendix.]
    Before recognizing Ms. Waters for an opening statement, let 
me welcome all Members to the hearing and extend a special 
welcome to Bob Gulledge, who is President of the Citizens Bank 
in my home State of Alabama, who last week was elected 
President of the Independent Community Bankers of America. I 
congratulate Bob on the appointment. We know you will serve 
Alabama well.
    Let me recognize Ms. Waters for any opening statement she 
would like to make.
    Ms. Waters. Thank you very much, Mr. Chairman. I think you 
framed the issue quite well in your opening comments, and I do 
believe, because we have heard these issues before in this 
subcommittee that there probably is a consensus in this 
subcommittee of support for both issues.
    I am interested in two aspects of these issues that have 
not been discussed in any thorough way. One is how much does it 
cost? Is this going to be a cost to the Treasury; if so, how 
much and how is it calculated? And then I think we got into 
discussion once before on how will the customers benefit from 
the interest that banks would receive if, in fact, we would 
repeal existing law. I am going to be looking for comments and 
raising questions in those two areas and would be very 
appreciative for explanations that would help me to resolve 
some of the questions that I have in these two areas. And I 
would also like to know from the Feds how it helps them with 
monetary policy to be able to pay interest on what is, I guess, 
known as the sterile accounts.
    So with that, Mr. Chairman, I will yield back the balance 
of my time.
    Chairman Bachus. Thank you, Ms. Waters.
    At this time, Mr. Toomey, do you wish to make an opening 
    Mr. Toomey. Thank you, Mr. Chairman, and I would like to 
commend you for having this hearing so promptly and moving on 
this legislation. As you pointed out, last year we had a huge 
success when we passed the Gramm-Leach-Bliley Act, repealed 
archaic Depression-era banking laws, and here we are able to 
address a further step forward in repealing what many of us 
believe is an out-of-date portion of that Banking Act of 1933, 
the prohibition on paying interest on business checking 
    It is just about time that we allowed regulation to catch 
up with the marketplace. The reality is that financial 
institutions with the wherewithal have maneuvered their way 
around this prohibition quite legally and appropriately, but it 
is a cumbersome process. They offer repos, implied in the form 
of services to customers, credits against bank charges. In 
fact, a quick search on the Internet, and we discovered 
numerous listings for banks offering, quote, ``interest on 
business checking,'' unquote.
    Unfortunately, of course, some banks cannot afford to 
purchase the software and the technology and the systems needed 
to circumvent these rules, and in any case it is very 
inefficient for banks to have to waste time and resources in 
inventing ways to get around unnecessary and inappropriate 
    So now it is well past time to repeal this ban and allow 
banks to develop products and services that will serve their 
customers, not the Government; allow businesses both large and 
small to have wider array of choices with their cash; allow 
small banks more tools to help them increase their core 
deposits, and frankly everyone will benefit from a repeal from 
unnecessary level of regulation.
    Early today I introduced the Business Checking Freedom Act 
which does repeal the prohibition on paying interest on 
business checking with a one year phase-in period. I would like 
to thank the other sponsors of the legislation, Mr. Kanjorski, 
Mrs. Roukema, Mrs. Hooley, Mr. Ney, Mr. Gonzalez, and Mrs. 
Capito. I took forward to the testimony of the witness. Thank 
you, Mr. Chairman.
    Chairman Bachus. Ms. Carson.
    Ms. Carson. Thank you very much, Mr. Chairman, for moving 
expeditiously on this issue concerning interest of the business 
demand deposits and permit payments of interest on sterile 
reserves. I could only replicate what has already been said 
very eloquently, so let me suggest then that I would use my 
limited time to say that we are honored today to have Mr. David 
Bochnowski from Munster, Indiana, the fine State of Indiana. 
For more than two decades, Congress has considered legislation 
that could repeal the ban on payment of interest or business 
demand deposits, and now we are here today to hopefully move 
forward in addressing an archaic rule. It is my firm belief 
that with people such as David Bochnowski present here today, 
that we will be able to take further steps toward resolving the 
    Most of you, no doubt, know that Mr. Bochnowski currently 
serves as Chairman of the America's Community Bankers, and has 
served as its director since 1994. Yet this position represents 
only one chapter of a life dedicated to public service. This 
gentleman from my State began his career as a special assistant 
to my good friend, who was our senator at that time, Senator 
Birch Bayh. Mr. Bochnowski later served as a law clerk for the 
U.S. district court in Indiana's southern district. He served 
as a trustee for Munster Community Hospital, as a commissioner 
for the Chicago Gary Airport Authority, and also served his 
country with valor in Vietnam. So it is a pleasure, Mr. 
Chairman, and Members of this subcommittee, to introduce to you 
my friend, Mr. Bochnowski here, who is scheduled for the second 
panel, the discussion. I yield back.
    Chairman Bachus. Thank you, Ms. Carson.
    Ms. Kelly, do you wish to make an opening statement?
    Mrs. Kelly. Thank you, Mr. Chairman. This afternoon, as I 
was walking over here, I heard the signs of spring. I heard the 
birds coming back and I noticed the buds emerging on the trees, 
and now I see Governor Meyer here before our subcommittee to 
talk about interest on business checking accounts, and sterile 
reserves, and that is an additional true signal that spring is 
here, don't you think?
    So Governor Meyer, we welcome you and thank you very much 
for coming back to talk with us about this. I want to quickly 
thank Chairman Bachus and Ranking Member Waters for agreeing to 
hold this hearing today. These issues are very important and 
they relate to another growing issue that we would hold 
hearings on in this Congress, and that is the ability of 
community banks to attract sufficient deposits to ensure safe 
and sound operation of the banks.
    The question I would like to explore with the witnesses 
today is how will the repeal of the prohibition of paying 
interest on corporate demand deposits affect the bottom line of 
the banks? I have introduced H.R. 974, the Small Business 
Interest Checking Account Act of 2001, and a Senate companion 
has been introduced today by Senator Chuck Schumer. This 
legislation contains three parts: first, it gives banks the 
authority to increase their sweep activities from the current 
six times a month to 24; second, it authorizes the Federal 
Reserve to pay interest on reserves; and third, it gives the 
Federal Reserve greater flexibility in setting reserve 
requirements. In crafting this legislation, I have consulted 
with the Federal Reserve, the Treasury Department, and the 
groups before us today to ensure that this legislation will be 
acceptable by all. In addition, Congressmen Toomey and 
Kanjorski have introduced legislation to repeal the current 
prohibition on business checking accounts.
    As has occurred in the past year, we anticipate these 
initiatives to be merged when we mark up the legislation, and 
in the course of the length of the transition period, these are 
going to be the biggest issues. So I look forward to discussing 
these issues with the distinguished witnesses that we have 
today, that have taken their time to join us. And I yield back 
the balance of my time.
    [The prepared statement of Hon. Sue W. Kelly can be found 
on page 44 in the appendix.]
    Chairman Bachus. Thank you, Mrs. Kelly.
    Mr. Cantor. I will be sure to say to all Members, please 
speak in the mike. That wasn't intended for you, Mr. Cantor.
    Mr. Cantor. I am sure I need no help. Thank you. I have no 
formal opening statement. I would like to extend my personal 
welcome to the panel witnesses, especially to Mr. Thomas P. 
Jennings, the Senior Vice President and General Counsel of 
First Virginia Bank from my home State, whose bank has a strong 
presence in the 7th District of Virginia in Richmond. Welcome, 
Mr. Jennings.
    Chairman Bachus. Thank you. Do we have anybody here from 
Missouri? Maybe we could recognize him next.
    Mrs. Hart from Pennsylvania.
    Ms. Hart. Thank you, Mr. Chairman. I also don't have any 
formal opening statement. I am pleased for the opportunity to 
be here at the hearing today and hear from such a distinguished 
panel on the issue. As a freshman, I am not as experienced as 
some of the others on some of the issues nationally when it 
comes to banking and financial services. However, I was very 
much involved on a State level as a State Senator, and I will 
be very much interested to see the private sector panel discuss 
these issues and answer some of the questions we have.
    My main concern is basically how little, and normally how 
little can Government become involved in the decisions made by 
financial institutions without causing them harm. Because my 
angle is basically that if we can regulate less, I would prefer 
to do it. However some questions have been raised to me from 
some of those involved on different ends of banking and 
different types of banking and the communities I represent 
about whether or not this is a good idea, and if it is a good 
idea at this time, I will be interested in hearing.
    So for any of the--especially panel two that is here, I 
will be very interested in hearing your response to those 
questions. And just general questions of interest I think to 
the Members of the subcommittee. Mr. Chairman I am honored 
obviously to be a part of this subcommittee and pleased to be 
here, and also not to discount panel one, but I will also be 
interesting in hearing really directly the amount of control 
they believe that they need to have when it comes to banks, 
especially making decisions about interest. Thanks, Mr. 
    Chairman Bachus. Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman. I would thank you for 
holding this hearing. I hoped we would have disposed of this 
issue in the last Congress, but we didn't, and I would hope we 
can dispose of it in this Congress rather quickly. It seems, at 
least on this side of the street, we are generally in 
agreement, so I hope we are able to move quickly on this. I 
yield back the balance of my time.
    Chairman Bachus. Thank you, Mr. Bentsen.
    Chairman Oxley, you are recognized at this time.
    Mr. Oxley. My opening statement is making its way up to the 
podium as I speak, and so I would defer to other Members with 
an opening statement until such time as it may arrive, and I 
think you would rather have that than me making it up on the 
    Chairman Bachus. And we earlier said, without objection, we 
would make those statements part of the record without the 
spoken word.
    Mr. Oxley. That would be a brilliant idea, and I would 
agree with that and ask unanimous consent that we do the same.
    Chairman Bachus. So moved. Thank you, Mr. Chairman.
    Mr. Watt.
    Mr. Watt. Thank you, Mr. Chairman. I will be brief. I have 
expressed my opinions about this in the last term of Congress, 
and have been a long supporter of not having money sitting 
around doing nothing, either in checking accounts or sterile 
reserves or otherwise. And I hope we are going to do something 
in addition to having hearings on it this time, and actually 
move some bill that will accomplish those objectives. Thank 
    Chairman Bachus. Thank you, Mr. Watt. Are there other 
Members of the subcommittee who would like to make opening 
statements? If not, Chairman Oxley.
    Mr. Oxley. Mr. Chairman, I think your initial idea was good 
that the statement be made part of the record. I just want to 
commend you on holding this hearing. This is a very important 
issue. And I appreciate the participation of the Members, 
particularly the Members who have been through this issue 
before, the gentleman from North Carolina, Mr. Watt, yourself 
and others, Mrs. Kelly, and we look forward to the testimony 
from the witnesses and hopefully a strong bipartisan support 
for this legislation. I yield back.
    Chairman Bachus. I thank you, Mr. Chairman. We did mention, 
as you referred to, that Mrs. Kelly and Mr. Toomey had actually 
sponsored the legislation last year and Mr. Watt, I recognize 
your role. At this time we will recognize the first panel made 
up of Governor Laurence Meyer, Federal Reserve Board Governor 
of the Federal Reserve System, who has been before this 
subcommittee four years in a row to testify about this subject. 
So we would expect a pretty smooth statement, I would think. 
And then, Acting Under Secretary of Domestic Finance for the 
Department of the Treasury, Donald Hammond. Secretary Hammond, 
we welcome you and Governor Meyer. And Governor Meyer, if you 
would like to lead off.


    Mr. Meyer. Thank you. Mr. Chairman, Representative Waters, 
and Members of the subcommittee. The Federal Reserve Board 
continues to strongly support legislative proposals to 
authorize payment of interest on demand deposits and interests 
on balances held by depository institutions at Reserve Banks. 
As we have previously testified, unnecessary restrictions on 
the payment on interest on demand deposits and balances held by 
Reserve Banks distort market prices and lead to economically 
wasteful efforts to circumvent these restrictions. 
Authorization of interest on balances at Reserve Banks would 
also help to ensure the continued effectiveness of current 
procedures for implementing monetary policy.
    The Board also supports obtaining an increased flexibility 
in setting reserve requirements, which would allow it to 
consider reducing the regulatory burden on depositories to the 
extent consistent with the effective implementation of monetary 
policy. As you know, the Federal Open Market Committee 
formulates monetary policy by setting a target for the 
overnight Federal Funds rate, the interest rate on loans 
between depository institutions of balances held at their 
accounts at Reserve Banks.
    As we have previously testified, the issue of potential 
volatility in the Funds rate has arisen in recent years because 
of substantial declines in required reserve balances owing to 
the implementation of automated sweep programs from reservable 
checking accounts to savings accounts that are not subject to 
reserve requirements. Nevertheless, despite a much lower level 
of required reserve balances, no trend increase in volatility 
has been observed to date. In part, this stability reflects the 
increasingly important role of contractual clearing balances. 
These clearing balances are the amounts that depositories 
contract to hold in their accounts at the Federal Reserve in 
addition to funds that will meet reserve requirements. 
Contractual clearing balances earn implicit interest in the 
form of credits that may offset charges for Federal Reserve 
services, such as check clearing.
    To prevent the sum of required reserves and contractual 
clearing balances from falling even lower, the Federal Reserve 
has sought authorization to pay interest on required reserve 
balances and to pay explicit interest on contractual clearing 
balances. Such interest payments could help maintain the level 
of these balances and forestall any potential increase in the 
volatility of interest rates. Authorization of increased 
flexibility in setting reserve requirements would also be 
desirable as it would allow the Federal Reserve to consider 
exploring the possibility of reducing reserve requirements 
below the minimum levels currently allowed by law. Such 
reductions would further remove incentives for wasteful reserve 
avoidance practices.
    To ensure the continued effective implementation of 
monetary policy with lower reserve requirements, however, we 
would need authority to pay interest on contractual clearing 
balances. Indeed, while the best outcome would be an 
authorization to pay interest on any balances held at the 
Federal Reserve, if the budget costs of interest on required 
reserve balances continues to inhibit its passage we would 
support a separate authorization of interest on contractual 
clearing balances which would have essentially no budgetary 
    Another legislative proposal that would improve the 
efficiency of our financial sector is elimination of the 
prohibition of interest on demand deposits. This prohibition 
distorts the pricing of transaction deposits and associated 
bank services. Some small businesses receive no interest on 
their deposits. In competing for the liquid assets of other 
businesses, banks set up complicated procedures to pay implicit 
interest on compensating balance accounts. Banks also spend 
resources and charge fees for sweeping the excess demand 
deposits of larger businesses into money market investments on 
a nightly basis. Such expenses would be unnecessary if interest 
were allowed to be paid on both demand deposits and reserve 
balances that must be held against them.
    In summary, the Federal Reserve Board strongly supports 
legislative proposals to authorize the payment of interest on 
demand deposits and on balances held by depository institutions 
at Reserve Banks, as well as increased flexibility in the 
setting of reserve requirements. We believe these steps would 
improve the efficiency of our financial sector and better 
ensure the efficient conduct of monetary policy in the future. 
Thank you.
    [The prepared statement of Hon. Laurence H. Meyer can be 
found on page 45 in the appendix.]
    Chairman Bachus. Thank you.
    Mr. Hammond. Let me say to both witnesses that without 
objection, your written statements will be made a part of the 


    Mr. Hammond. Thank you, Mr. Chairman, Chairman Bachus, 
Representative Waters, Members of the subcommittee. I 
appreciate this opportunity to appear before you this 
afternoon. I appreciate this opportunity to present the 
Treasury Department's views on repealing prohibitions on the 
payment of interest on business checking accounts, and on 
permitting the payment of interest on reserve balances that 
depository institutions maintain at the Federal Reserve. The 
Treasury Department supports permitting banks and thrifts to 
pay interest on business deposits. While sympathetic to many of 
the arguments in favor of permitting the Federal Reserve to pay 
interest on reserve account balances, we are not prepared to 
endorse this proposal at this time.
    The Treasury Department has consistently supported 
provisions repealing the prohibition on paying interest on 
demand deposits. Repeal of this prohibition would eliminate a 
needless Government control on the price that banks must pay 
for business deposits consistent with the earlier elimination 
of Regulation Q rate ceilings on other deposits. The result 
should be more efficient resource allocation. Most proposals 
that would have allowed banks and thrifts to pay interest on 
demand deposits would have delayed repeal of the current 
prohibition for a number of years and provided for transitional 
mechanisms. The Treasury Department continues to prefer a 
relatively quick repeal on the prohibition on paying interest 
on demand deposits obviating the need for special transitional 
    The Federal Reserve Act requires depository institutions to 
maintain reserves against certain of their deposit liabilities. 
Institutions typically meet these reserve requirements through 
vault cash, and a portion of their reserve balances at a 
Federal Reserve bank known as required reserve balances. 
Depository institutions may voluntarily hold reserve balances 
above the amount necessary to meet the requirements which are 
called excess reserves. Required reserve balances and excess 
reserves held at the Federal Reserve do not earn interest, 
hence they are referred to as stale reserves. Since the 
beginning of 1990s, required reserve balances at the Federal 
Reserve banks have declined by 83 percent. Three factors may be 
primarily responsible for the decline: one, regulatory actions 
taken by the Federal Reserve in the early 1990s reducing 
reserve requirements; banks' growing use of new products and 
technology, such as retail sweep accounts to minimize required 
reserves; and growth in the use of vault cash to meet reserve 
requirements as increased ATM usage has increased the need for 
such cash. The proportion of reserve requirements met by vault 
cash has risen from 44 percent in December of 1989 to 85 
percent in January of this year.
    The three principal grounds for paying interest on reserve 
balances are to: one, promote economic efficiency; two, 
facilitate monetary policy; and three, lower cost to the 
banking industry.
    Permitting the payment of interest on reserve balances 
might lead to greater economic efficiency. Banks have expended 
considerable resources to avoid holding non-interest-bearing 
required reserve balances. If banks earned interest on these 
reserve balances, they would be less likely to expand the use 
of sweeps and might unwind some existing sweep programs.
    As you heard from the Federal Reserve, the decline in 
required reserve balances could lead to greater short-term 
interest rate volatility, although such volatility is not a 
serious problem at present. For various reasons, the demand for 
balances to meet reserve requirements is more stable than the 
demand for balances to clear transactions through the Federal 
Reserve Fedwire system. Thus, the smaller the required reserve 
balances, the greater the role that less predictable daily 
clearing needs of banks would have in determining the demand 
for reserves. This may make it more difficult for the Federal 
Reserve to supply the amount of reserves consistent with its 
Federal funds rate target.
    Banks have long contended that the cost of reserve 
requirements, forgone earnings, put them at a competitive 
disadvantage relative to non-bank competitors that are not 
subject to reserve requirements. Yet the foregone earnings that 
depository institutions currently incur through reserve 
requirements must be viewed in their context to the overall 
relationship to the Federal Government, including benefits 
derived from Federal deposit insurance and access to the 
Federal Reserve payment system and discount window.
    The Office of Management and Budget, a congressional budget 
office, have, in the past, estimated that paying interest on 
required reserve balances would cost approximately $600 million 
to $700 million over a five-year period. Both the OMB and the 
CBO estimate take into account the effect on tax revenues from 
depository institutions that receive interest. Some proposals 
have provided for an offset to the budget cost by transferring 
a part of the Federal Reserve surplus to the Treasury. It is 
true that in some previous years, budget accounting rules have 
permitted the transfer of Federal Reserve surplus funds to the 
Treasury to count as receipts that would offset the cost of 
other programs. Yet over time, transfers of the surplus do not 
result in budget savings.
    In sum, Congress should act to repeal prohibitions on 
paying interest on business checking accounts at banks and 
thrifts. This would eliminate unnecessary restrictions on this 
institution's ability to serve their commercial customers. 
Proponents of paying interest on reserve balances maintained at 
the Federal Reserve have put forth a number of reasons in their 
    As a general matter we are sympathetic to many of the 
arguments put forth by those proponents, particularly with 
respect to monetary policy. At the same time, however, we are 
also mindful of the budgetary costs associated with this 
proposal which would be significant. The President's budget 
does not include the use of taxpayer resources for this 
purpose. At this time, then, the Administration is not prepared 
to endorse that proposal. I appreciate the opportunity to 
appear before you and I am happy to respond to any questions 
you may have.
    [The prepared statement of Donald V. Hammond can be found 
on page 56 in the appendix.]
    Chairman Bachus. Thank you.
    I appreciate the testimony, summary of the testimony from 
the first panel, and at this time we will permit Members five 
minutes to ask you any questions they may have. And I am going 
to go ahead and read down the order that we are going to do 
this in the order that the Members arrived. I am going to go 
from Majority, we will alternate, but on the Majority side, Mr. 
Cantor, Mr. Toomey, Mrs. Biggert, Ms. Hart, Mr. Lucas, Ms. 
Kelly, Mr. Rogers, Mr. Bereuter, Mr. Ferguson, Mr. Tiberi, Mrs. 
Capito, Mr. Manzullo and Mr. Weldon.
    On the Minority side, Ms. Waters, Ms. Carson, Mr. Bentsen, 
Mr. Watt, Mr. Shows. If I note that a Member is no longer at 
the hearing, I will just simply go to the next Member down, and 
at this time I will recognize Mr. Cantor for questioning.
    Mr. Cantor. Thank you, Mr. Chairman.
    I would like to direct this question to Mr. Hammond, and 
really ask you, I think, a question of fairness and the fact 
that if we are going to lift the ban on the interest on 
business checking, why is it that banks couldn't receive 
interest on their sterile reserve deposit? And to me, there is 
this question of the cost of funds versus getting return on the 
funds deposited. How do you answer that, leaving aside sort of 
the budgetary concern of the Administration?
    Mr. Hammond. I think from a standard of balance and equity, 
the match of payment of reserves on the liabilities side 
combined with the payment of interest on business checking 
gives the opportunity for balance within the system, and I 
think with that regard, the two proposals make sense looking at 
them together. As I said in my testimony, we are quite 
supportive of a lot of arguments related to the cost or to the 
proposal for paying interest on reference. I think the final 
component is that there is a cost to be important by the 
general taxpayer, related to the fact at that time, Federal 
Reserve system returns its earnings to the Treasury on an 
annual basis. As a result, the payment of interest on reserves 
does, in fact, create a cost to the general funds.
    Mr. Hammond. Leaving aside that provision, I think that the 
proposal to pay interest on the reserves is one that we support 
from the standpoint of the other provisions. But obviously, the 
cost is a significant issue.
    Mr. Cantor. Thank you, Mr. Chairman. I yield back the 
balance of my time.
    Chairman Bachus. Ms. Waters.
    Ms. Waters. Thank you, Mr. Chairman.
    As I indicated in my opening remarks, I wanted to know more 
about the cost to the public, and while I don't want to get you 
all embroiled in the discussion about the $1.6 trillion tax cut 
that we are discussing here, the fact of the matter is some of 
us are very concerned about how we pay for it. If you are 
suggesting that paying interest on the sterile reserves could 
cost us $600 to $700 million over a five-year period of time, 
could you calculate that out over a ten-year period of time? We 
are dealing with a tax cut over a ten-year period of time and 
we are looking at, well basically, you know, how are we going 
to do this? So what does this calculate out to? It is double 
more this amount, or it is more than this amount over a ten-
year period of time?
    Mr. Hammond. I am not aware of any estimates that extend 
beyond the five year horizon that both OMB and the 
Congressional Budget Office have independently performed. I 
suspect that what you would see is a fairly even balance unless 
you saw things such as growth in, for example, clearing 
balances which, if allowed to pay interest on those, the 
Federal Reserve System may very well find that there is a 
reduced cost from the overall proposal.
    Ms. Waters. Also, I would like to ask you, as I am going to 
ask Mr. Meyer if I have time, what--if there is additional 
earnings in the flow of income on the payment of interest from 
the Feds to the banks, how can consumers benefit from this? Did 
we discuss this before, what the banks do with this additional 
revenue and whether or not it would lower interest rates? What 
can it do for the average consumer?
    Mr. Hammond. I think any opportunity to improve the 
profitability of financial institutions certainly has to have 
indirect benefits for consumers, because obviously, the 
increased earning capacity of the financial institution should 
lead to reduced fees in certain areas in their business. How 
those reductions in fees would flow through on an average basis 
I think would vary from institution to institution.
    Ms. Waters. Should we support this repeal of law that would 
allow for the payment of interest on these accounts in the 
Federal Reserve accounts, the sterile accounts? Should we 
encourage, in some way in the legislation, the banks to reduce 
fees or to show how their customers are benefiting from this 
new revenue?
    Mr. Meyer.
    Mr. Meyer. I would not particularly encourage that. I would 
leave it to the competitive financial system we have that would 
induce banks to pass along the benefits of interest on reserves 
in a variety of ways, and I wouldn't want to instruct them 
precisely on how to do that. I think the most likely outcome 
would be somewhat higher interest rates on the transaction 
deposits that are no longer backed by the sterile reserves. It 
could be that banks might charge somewhat lower interest rates 
on some loans or they might charge somewhat lower fees for some 
services. There are a whole variety of ways that they could 
adjust, but I wouldn't want to micromanage that and tell them 
this is the way you ought to adjust. It is up to bank 
management, it is up to the competitive forces in the markets, 
to determine precisely what those adjustments are.
    Ms. Waters. If you had to make the argument to the taxpayer 
who would be told that it would be a cost to the taxpayer to 
pay interest on these accounts, how could you tell the taxpayer 
that they were going to benefit, if we are not going to 
encourage in some way, some broad way, how could you tell the 
taxpayers that yes, you got support, the bank is getting a new 
source of revenue; no, you are not going to mandate in any way 
that the customers benefit from that; but yes, it is going to 
cost them money for this to happen, how do you reconcile that 
    Mr. Meyer. Well, three ways. First of all, that it would 
reduce the necessity of banks engaging in wasteful spending to 
get around these restrictions. Setting up a sweep account has 
no social benefits at all. It is just to avoid a restriction. 
So that is a total benefit to society that that money isn't 
wasted. Second, I would tell them that they should look forward 
to, and could reasonably anticipate, that they will get either 
higher interest rates or face lower loan rates, because that 
will be an outcome of this--a natural outcome of this due to 
our competitive system. And third, I would tell them that they 
can look forward to continued effective monetary policy, 
because this will also maintain the effectiveness of our 
current operating procedures.
    Ms. Waters. Thank you. I believe my time is up.
    Chairman Bachus. Thank you.
    Mr. Toomey.
    Mr. Toomey. Thank you, Mr. Chairman.
    Actually, perhaps if both of you gentlemen could address 
this briefly. You know it is true we are working on a, in my 
view, unfortunately modest tax relief package of $1.6 trillion 
dollar. Some of us would like to see considerably larger. It is 
all focused on individual tax relief, as you gentlemen very 
well know. But when it comes to corporate taxes, it is not the 
failure to pay interest on stellar reserves in a way, a hidden 
or implicit tax on a category of assets rather on the 
profitability of a firm, in other words it is a cost imposed by 
Government that bears no relationship to the profitability of 
the firm, like most of our methods of tax incorporations, but 
rather deals with a category of assets, and isn't that, in many 
ways, an inefficient way to tax corporations?
    Mr. Meyer. Well, it is, it is often referred to as an 
implicit tax, and I think it is a particularly inefficient tax 
because it generates these totally wasteful expenditures, and 
so I quite agree.
    Mr. Hammond. I would certainly agree that it is a cost that 
is unrelated to other activities of the business. It is also a 
cost that, as Governor Meyer pointed out, can be managed 
through incurring other costs to avoid that type of 
relationship. That would seem to be, all things being equal, 
not the most effective way of going about collecting that type 
of revenue.
    Mr. Toomey. So if you had to prioritize the kinds of taxes 
as a general matter, that if we were looking at ways to relieve 
the tax burden on the corporate sector of our economy, for 
instance, would this be a kind of tax that might deserve a 
priority, because it has additional negative consequences that 
go with it above and beyond those negative consequences that 
are associated with any kind of tax?
    Mr. Hammond. I think, speaking from my experience, and keep 
in mind I am not certainly an expert on taxation by any means. 
I think any time you try to prioritize various costs against 
each other, you have to see the complete list. All I could tell 
you is that it does appear to be a very inefficient way of 
generating revenue. Where that would rank in a listing of 
priorities of various other types of business expenses or 
business taxes, I don't know.
    Mr. Toomey. Moving on for a moment to interest on business 
checking accounts, could either of you maybe develop a little 
bit your thoughts on the nature of and the costs associated 
with the ways that banks have had to find ways around this 
decades-old prohibition?
    Mr. Meyer. Well, there are several ways. One of them is 
setting up very complicated procedures to pay implicit interest 
through compensating balances. These are fairly complex 
arrangements. You have to keep track of a lot of different 
services that are being provided to the businesses to 
compensate them for the failure to pay interest on the demand 
deposits. That is a very inefficient way relative to simply 
paying interest on demand deposits.
    A second way is setting up sweep accounts where balances 
are taken out of the demand deposit accounts and swept into 
either open market instruments or into savings accounts that 
pay interest. Now, that can be done, but there is a fixed cost 
of setting up these arrangements. That can be quite large, and 
there is a maintenance cost every year of implementing those. 
So these are very costly procedures that would be totally 
unnecessary if we allowed the payment of interest on demand 
    Mr. Hammond. I would agree with that analysis.
    Mr. Toomey. OK. My last question, if time still permits, is 
your--each of your thoughts on a phase-in period. What is the 
appropriate period of time the phase-in a repeal of this 
prohibition? There has been suggestion that it be immediate and 
some have suggested several years. I am just curious to have 
the benefit of your thoughts on this.
    Mr. Hammond. I think following up on your last question, 
Treasury feels that the shorter the transition period, the 
better. In fact, even no transition period would be 
appropriate. From the standpoint that the longer that you have 
of a transition or special arrangements for transition 
processing, you create some of the same costs and 
inefficiencies that the sweep programs and other comparable 
programs have today.
    Mr. Meyer. Well, I would agree. I think our preference 
would be for either no transition or a very short transition. 
Otherwise, what we are doing is maintaining the competitive 
advantage of some players in the market, the larger banks that 
have sweep programs already relative to the smaller banks that 
don't, providing differential access to the larger firms that 
can take advantage of compensating balances on sweep accounts 
relative to the small businesses that can't. We have said, 
however, in the interest of achieving a consensus and a 
compromise, if there was a short transition period, we 
certainly wouldn't object to that.
    Mr. Toomey. Thank you both.
    Mr. Chairman, I yield the balance of my time.
    Chairman Bachus. Mr. Toomey, again, we want to thank you 
for your diligence on this legislation that we passed a few 
years ago.
    At this time I will recognize Ms. Carson.
    Ms. Carson. Yes. Thank you, Mr. Chairman.
    I want to try to be quick with this. We passed legislation 
that allows automatic electronic transfers of a lot of Federal 
checks, like Social Security checks, civil service retirement, 
and so forth, which obviously arrive at your institutions the 
last day of the month prior to the time they are due, first day 
of the month. They don't collect until the third of the month, 
and so forth. The banks are obviously, at that particular time, 
drawing a lot of interest on that deposit for those couple of 
days, and so forth, that they happen. Who do you pay that 
interest to? The money's sent there by the--pardon me, not you, 
but how is that interest money paid once it is received by the 
financial institution? Because it was orchestrated by the 
Federal Reserve, you know what I am saying? I am glad you do, 
because I can't figure out what I am saying.
    Mr. Meyer. Well, there is a period after which it must be 
credited to the account of the person who is receiving that 
deposit, and from then on the interest goes to the deposit 
    Ms. Carson. Right. But during those 3 or 4 days that the 
bank has the money, that the customer can't draw from, the 
money's there but the customer can't draw from it.
    Mr. Hammond. Actually, in the normal course with electronic 
payments, we make the cash available the same day that it is 
available to the consumer, to the financial institution. What 
frequently happens is that the financial institution gets 
advice of the payment in advance of the availability of the 
funds, but, for example, for a Social Security payment, where 
it would be available on the third of the month, which would be 
the date that the check would normally arrive, if they are 
getting an electronic payment, they immediately have available 
funds in their account on the third of the month for that type 
of payment.
    Ms. Carson. I want to ask you, I know this has nothing to 
do with this legislation on interest being on checking 
accounts, but I did want to say, and you sort of touched upon 
it, one of the principal arguments for two- or three-day delay 
on interest-bearing checking accounts, it is banks who 
currently offer sweep accounts and other alternatives to 
interest-bearing checking accounts, will need time to unwind 
their current arrangements with their business customers?
    Now, I know you have been sort of talking about that. But 
with a long transition period with the 24 transactions per 
month MMDA, that is the money market deposit account, financial 
institution also incur cost at establishing 24-hour transaction 
MMDAs. Then at the end of the transaction period, those 
arrangements would have to be unwound. Doesn't a long 
transition period needlessly increase the cost and burdens for 
both financial institutions and their business customers?
    Mr. Meyer. I would agree. I believe it does.
    Mr. Hammond. I would say that a transition period doesn't 
offer any benefits to the customers or to those institutions 
who today don't have other types of institutional arrangements. 
So I don't see any justification for an extended transition 
    Ms. Carson. But is your belief that if this bill becomes 
law then you don't have to, you won't have the concern about 
the transition periods and----
    Mr. Meyer. No, I think that banks could manage that process 
very effectively. I don't think it is, by any means, a 
necessity to have a transition period, but it is one of the 
balancing forces out there. There certainly are going to be 
banks that say they have entered into relationships with 
customers that build in these sweep accounts. These sweep 
arrangements have a certain period over which they hold. The 
banks would prefer a transition period that would allow them to 
get the benefit of these arrangements. But on the other hand, 
during that period, these will be all the other banks that 
don't have the opportunity to have sweep accounts and all the 
small businesses that won't have opportunity to have interest-
bearing accounts. So we have to balance those two forces.
    Ms. Carson. Yeah, I favored the legislation, so don't--you 
know, misread my inquiry.
    Mr. Chairman, I would yield back.
    Chairman Bachus. Thank you, Ms. Carson.
    Mrs. Biggert.
    Mrs. Biggert. Thank you, Mr. Chairman.
    Mr. Hammond, one of the witnesses that we will hear from 
later today in his written testimony has said that implementing 
interest rates on the business checking accounts could, in 
fact, hurt small banks disproportionately, because they will be 
forced to raise additional deposits to offset the costs of 
moving money from interest-free deposits to interest-bearing 
accounts, but we are also--that this will help community banks 
retain commercial checking accounts. Do you believe that small 
banks could be hurt by allowing interest to be paid on interest 
checking accounts? It will help them to retain large business 
accounts and keep those large business accounts from jumping 
over to other financial service industries?
    Mr. Hammond. I think the ability for banks to pay interest 
on business checking accounts gives small financial 
institutions, in particular, an increased competitive advantage 
that they don't otherwise have today. They don't have the 
capability of offering some of the more complicated or more 
costly sweep relationships, nor do they have the ability to 
compete effectively against, for example, securities firms.
    So I think over the long term, this provision would allow 
small banks to retain existing checking and deposits and put 
them on a more equal footing to be able to obtain additional 
deposits going forward.
    Mrs. Biggert. But will this still force them to raise, they 
will have the raise their deposit level?
    Mr. Hammond. I think obviously there will be an increase in 
cost as they phase this from however they approach the payment 
of interest on business checking accounts, but the offset to 
that is that today, for business customers who want interest on 
their checking deposits, they have gone somewhere else if they 
can't find that service at the small bank. So as a reality, 
they may, in fact, find they are able to lure small businesses 
back into their fold in that environment.
    Mrs. Biggert. Mr. Meyer, would you agree with that?
    Mr. Meyer. Yes, I also think the main beneficiary would be 
smaller banks and that, in addition, while they would pay 
interest on these deposits, deposits are still a relatively low 
cost source of funds to community banks, and they need the 
opportunity to compete effectively for them with non-banks.
    Mrs. Biggert. So you wouldn't see them losing the business 
accounts to other financial services?
    Mr. Meyer. No. To the contrary. Now I think one should 
understand that there are banks who have customers that are 
relatively insensitive to interest rates and are now getting 
zero on their balances. I can understand that some banks would 
like to have a situation where that could continue. I am not 
sure that that is in the public interest, so I would support 
the legislation.
    Mrs. Biggert. Thank you.
    Thank you, Mr. Chairman. I yield back.
    Chairman Bachus. Thank you, Mrs. Biggert.
    At this time, Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman.
    Governor, as I said at the outset, I had thought we had 
done this already and we had on our side of the Capitol, and so 
hopefully we can do it now. And I look at the panel that is 
coming after this and I didn't get through all the testimony, 
but I am still looking for somebody who is opposed to this, but 
I guess I also want to say I agree with you on the transition 
period. I don't see any reason why sweep accounts that have 
been structured for banks to pay interest to their customers 
can't be unwound. These are all short term sweep accounts 
anyway, so they can remain liquid, and I would hope that if 
there is a problem, that somebody will present that to the 
subcommittee so we can look at it. But it seems to me that 
there is sufficient time to make a transition for this. In 
addition, it would seem to me that there would become a very 
apparent marketplace in the future for providers of sweep 
accounts to smaller banks who aren't going to want to do this 
on their own, that this will be a service that they will buy. 
So I don't see where anybody's ox gets gored in this process.
    Let me ask you about your discussion in your testimony, 
though, regarding reserve requirements. You talk about maybe 
this providing you with an opportunity with the Fed, the 
opportunity if Congress is willing to, I guess, reduce the band 
between the 8 and 14 percent to a lower percent, but you also 
say currently, the Fed is, I think, a 10 percent reserve 
requirement level, so you are not at the low end anyway. Some 
of my colleagues have proposed a complete repeal of the reserve 
    In your testimony, you sort of hint at that, but I am not 
sure if you go as far. So my first question would be, are you 
arguing that we ought to repeal the reserve requirement, or are 
you arguing that we ought to just give you greater flexibility 
so the Fed can explore other means with which to implement 
monetary policy?
    And secondary to that, given the possibility that we might 
actually pay down all of the Federal debt, publicly held debt, 
and of course, it is not a done deal yet, but it is an outside 
possibility, I realize the Fed has undertaken a study of other 
types of securities with which to conduct open market 
activities. In the event that there is not a sufficient 
replacement for the Fed to conduct open market activities to 
the tune that you do currently, would it be wise to eliminate 
reserve requirements altogether as a tool of monetary policy, 
or is it so antiquated that it really doesn't do any good?
    Mr. Meyer. In the past, we have been concerned that the 
total of required reserves and contractual clearing balances 
would fall to such a low level that it would impede the 
effective operation of monetary policy.
    Now, in fact, as it has fallen, we haven't seen an 
increased volatility in the Federal Funds rate. Now we have the 
prospect that if we pay interest on required reserves and we 
pay interest on contractual clearing balances, these deposits 
will grow, although we don't really need them higher. So if 
they grow, it would provide us with an opportunity to lower the 
required reserve ratio. So one of the benefits here is we might 
be able to have the same level of deposits with the same 
effectiveness of monetary policy, and lower required ratios at 
the same time.
    Whether that would be possible would depend on the 
experience once we implemented interest on required reserves 
and interest on contractual clearing balances, seeing how much 
they would grow, and then we would have to very gradually see 
to what extent we might be able to lower reserve requirements.
    Mr. Bentsen. If I might interject before my time is up, I 
think I know where you are heading in saying that instead of 
having a mandatory reserve requirement you could, in effect, 
buy the reserves that you need to conduct monetary policy, and 
I appreciate that, but is there an opportunity where an 
imbalance in the economy and an imbalance in interest rates 
might otherwise cause banks to put their funds elsewhere than 
at the rate that the Fed is paying, or would the Fed be paying 
market rates so there wouldn't be any spread between the public 
market and the Fed market?
    Mr. Meyer. I think we would be paying the rate where we 
could control the total level of the required and contractual 
balances to achieve the stable and predictable level that is 
necessary for monetary policy.
    Mr. Bentsen. But then puts that in the possibility of an 
interest rate trap itself?
    Mr. Meyer. No, I don't believe that would be a problem at 
    Mr. Bentsen. Thank you, Mr. Chairman.
    Chairman Bachus. Thank you, Mr. Bentsen.
    Ms. Hart.
    Ms. Hart. Thank you, Mr. Chairman.
    I have one question, and actually either of you might be 
able to shed some light on it. Some concern, a lot of concern 
has been raised by some of the larger institutions in the 
communities I represent regarding problems that could be caused 
to some of the small community banks as a result that if they 
are permitted to offer interest on their business checking that 
even though it isn't required, they will all feel a need to do 
it and may basically lead us into some other kind of banking 
disaster. I would just like to have either one or both of you 
shed any light on whether there is any merit to that at all?
    Mr. Meyer. I want to make sure I got your question 
correctly. I believe you said that larger banks are worried 
that this will cause a problem for smaller banks. Is that what 
you said?
    Ms. Hart. Larger banks and those who have other kinds of 
investment instruments, yes.
    Mr. Meyer. It is very kind of the larger banks to worry 
about the smaller banks. I think we all appreciate that. I 
think maybe we should hear from smaller bankers who you will 
hear from on the next panel, and I think they will tell you 
that they are probably better off looking after their own 
interest than the larger banks. It may be the case that larger 
banks want to preserve their competitive advantage from sweeps.
    Ms. Hart. I certainly understand that, but my question to 
you was because I, unfortunately, like a lot of us, lived 
through the Resolution Trust Corporations' activities and saw a 
lot of strange things happen in the banking industry in what, 
the late 1980s, I guess, and----
    Mr. Meyer. We have had a lot of experience with banks 
paying interest on transaction balances, NOW accounts, that has 
proved very successful. It has been a benefit for banks and for 
consumers. I think the main point here is that giving small 
banks the opportunity to pay interest on demand deposit is 
going to make them more competitive in the market for 
relatively inexpensive funding and strengthen their financial 
conditions and competitiveness in the financial system.
    Ms. Hart. So you see it all around as a benefit to the 
complete market, it is not going to weaken any player in the 
market necessarily.
    Mr. Meyer. No. I think it does level the playing field. 
That does mean that some banks that had competitive advantages 
might find the current circumstance better, but you have to 
weigh that against that the benefits of leveling the playing 
    Ms. Hart. Absolutely.
    Mr. Hammond.
    Mr. Hammond. It is really hard to add to that. I think I 
agree completely with Governor Meyer. Today what you have is a 
competitive imbalance to some extent between small banks and 
some of the larger banks with more sophisticated product 
offerings. This does, in fact, bring things more into an 
equitable balance situation. Obviously, that means that someone 
has to give something up in order for someone else to be on a 
more equal footing.
    Ms. Hart. Well, the other issue is, I think, there are 
almost not in the same market at this point, and by doing this, 
we place all of the financial institutions in the same market. 
Do you see any danger caused, because really the different 
tiers of the market really will become one in a lot of ways?
    Mr. Meyer. No. Small banks compete with larger banks and 
they compete with non-banks, and we are just giving them a 
better opportunity to be a more effective competitor in that 
    Ms. Hart. I was just playing devil's advocate, by the way. 
Thanks very much.
    Thank you, Mr. Chairman.
    Chairman Bachus. Thank you, Ms. Hart.
    Mr. Watt.
    Mr. Watt. Thank you, Mr. Chairman.
    I was going to start off by fussing at you all for why we 
were limiting this to business accounts, and then I realized 
that you did it for individuals, or we did it for individuals 
before I came to Congress. I think I had forgotten about that, 
because I never have enough money in my account to qualify for 
any interest, but it does raise an interesting question, which 
is whether either the Fed or the Department of the Treasury or 
any of the other regulators are keeping any statistical 
information about how effective NOW accounts have been, and the 
extent of individual deposits that are actually drawing 
interest on or having interest paid on them. Do you all have 
any information about that?
    Mr. Meyer. Yes. There are $240 billion of what we call NOW 
accounts, interest-bearing transaction accounts held by 
    Mr. Watt. What percentage of total deposit is that of 
    Mr. Meyer. That is relative to demand deposits, some of 
which are held by households also, but most of which are held 
by businesses, that are about $315 billion.
    Mr. Watt. So it is working pretty well then is your 
    Mr. Meyer. Absolutely.
    Mr. Watt. OK.
    Mr. Hammond, I am wondering, since this is a new Treasury 
Department, this turnover, whether there is any likelihood that 
you all are going to reevaluate your position on the reserve, 
on the payment of interest, because it seems to me, I guess I 
am kind of like Mr. Toomey. It seems inconsistent with the 
philosophy that this is the Government's money rather than the 
individual banks, or even the depositor's money, and that 
somehow the Government is entitled to this money in this budget 
equation. I understand that we could use it and we could spend 
it, but it just--your argument seems just completely 
inconsistent with the arguments that I have heard in support of 
returning tax moneys to people. And the President's question, 
in his address to the joint session where he asked who the 
surplus belongs to, my response to that by the way, is, it 
doesn't belong to anybody until it materializes. But if you 
follow what he was saying, it doesn't belong to the Government, 
it belongs to the depositor or the taxpayer, or so the bottom 
line is, it is likely that you all are going to reevaluate your 
position that you have testified about today, or you don't see 
that happening?
    Mr. Hammond. I think what is likely is that more, as more 
appointees come into the Treasury Department, people will look 
at legislation that is going through the process and make 
independent judgments at that point in time, and I think 
additionally, what we have to keep in mind with regard to the 
cost, if you will remember back, what I said is that we are 
concerned about where it falls into the priorities of the 
Administration today, vis-a-vis the surplus.
    Mr. Watt. If you put somebody else's money in the 
priorities sometimes.
    Mr. Hammond. Obviously the decisions and the positions that 
people have to take depend on, to the extent that this were an 
expenditure of $700 million over five years, then another 
expenditure of $700 million over five years would have to be 
removed from the budget, all things being equal. I think it is 
that tradeoff and that debate which is likely to continue 
throughout the budget process. So I think it is very likely 
that new appointees also come in and look at the issue and look 
at the pros and cons and go forward from there.
    Mr. Watt. So I guess your, the bottom line of what you are 
saying is if we move this bill, they are more likely to look at 
it quickly and may reevaluate what you are saying.
    Mr. Hammond. They will certainly have the opportunity to be 
focused on that as they come on board, yes.
    Mr. Watt. OK. While they are in the process of doing that, 
would you also deliver them a message that I would like for 
them to take a look at, our Mr. Lucas' bill, H.R. 557, which 
seems to me to fit kind of in the same category of things where 
we could refund some of the BIF and SAIF overcapitalized 
accounts. So if they are reviewing, can you deliver a message 
to them that we would like for them to take a look at that one 
    Mr. Hammond. I think deposit insurance reform will be 
certainly a very important issue to be debated going on this 
year, and I suspect they will be quite focused on that and 
other components of this.
    Mr. Watt. Thank you, Mr. Chairman.
    Chairman Bachus. Thank you, Mr. Watt.
    Mrs. Kelly.
    Mrs. Kelly. Thank you, Mr. Chairman.
    Governor Meyer, I welcome you again. I think you probably 
are familiar with a conversation that I had with Chairman 
Greenspan when he was here on February 28th. I just want to 
reestablish for the record a couple of the points that were 
made in that conversation. As I understood him to say, the Fed 
wants these bills to be merged, and he wants them to go forward 
as one bill; is that correct?
    Mr. Meyer. The main objective is to get both parts passed. 
Whether they pass as one bill or two bills is of no consequence 
to us, but we would be delighted to have it in one bill.
    Mrs. Kelly. Well, for efficiency sake, it is probably a 
good thing for them to come through together. The second thing 
is that the Fed supports my language that allows for the 
payment of interest on the reserves held at the Federal Reserve 
Bank, and the language that gives the Fed greater flexibility 
in setting the reserve requirements; is that correct?
    Mr. Meyer. That is correct, and just to make it clear, that 
bill, it is my understanding, is written so that it allows the 
payment of interest on all three kinds of deposits, that is, 
required reserves, contractual clearing balances, and excess 
reserves. So it has that flexibility and it gives us a lot of 
    Mrs. Kelly. Yeah, that is exactly the way we viewed it.
    Mr. Hammond, you indicated in your testimony that the 
Treasury Department is reviewing the policy of paying the 
interest on reserves held at the Federal Reserve banks. I would 
kind of like to get a commitment that the Treasury and the Fed 
will work together with our staffs so that we can do this all 
properly, efficiently and as cleanly as possible while we can 
address any concerns that the Treasury may have, and I just 
wanted to say that for the record, and get your agreement that 
that is the case.
    Mr. Hammond. We would be delighted, as we always are, to 
work closely with you and the Federal Reserve on these 
provisions. I would include that certainly to the extent that 
we look at budget costs, however, that we also have to include 
in those deliberations the Office of Management and Budget, as 
they are the Administration's chief keeper of the budget 
    Mrs. Kelly. I am hopeful we will be able to resolve that 
issue though.
    Mr. Chairman, that is all I am going to say in the interest 
of speeding this up. I am going to yield back the balance of my 
    Chairman Bachus. Thank you, Mrs. Kelly.
    Mr. Rogers.
    Mr. Rogers. Thank you, Mr. Chairman.
    I was just trying to determine here from some CBO 
estimates, and your calculations of that $600 to $700 million 
to your budget, that was a static calculation of costs, kind of 
in a parochial view. Have you looked, or has anyone looked at 
the increased revenue that would be received by the 
accumulation of assets by those individual businesses from 
interest earned, which they previously do not enjoy?
    Mr. Hammond. I am not sure if I understand your question 
    Mr. Rogers. Well, the Federal Treasury will gain more money 
on the taxes paid by corporations on the increase of interest 
of which they don't enjoy now on those accounts; is that 
    Mr. Hammond. Let me just back up and make sure I understand 
the question correctly. If I understand what you are asking, is 
the benefit that the business community will obtain from the 
payment of interest on reserves factored into the calculation 
of the net costs to the Government, and the answer to that is 
no, it is not. What the CBO and OMB projections are based on is 
an assumption on what it will be from a budget standpoint to 
Federal revenues and expenditures. So obviously, to the extent 
the overall economy benefits from moving some of that money out 
of the Federal coffers into the commercial banking system, that 
is another consideration.
    Mr. Rogers. I am not sure we are on the same sheet of 
    Mr. Hammond. OK.
    Mr. Rogers. Just from what Congressman Toomey talked about, 
the administrative costs are obviously going to be less with 
the passage of this bill. Higher reserves that may net is going 
to be some increase to the Fed. But also, the Federal Treasury 
will gain in corporate taxation from gains in interest that 
small businesses don't currently pay, because they don't 
accumulate that asset. Am I correct?
    Mr. Hammond. You are correct.
    Mr. Rogers. I have not seen anywhere in the calculations 
that I can find, so $600 to $700 million doesn't seem very 
real--it is a very static number.
    Mr. Hammond. My understanding is those effects are actually 
factored into both the OMB and CBO calculations. We can verify 
    Mr. Meyer. They use a 25 percent assumed tax rate, and that 
is explicitly in their calculation.
    Mr. Rogers. That is a little different than what I am 
reading here from CBO. So maybe we can get all on the same 
sheet of music, and somehow some way maybe afterward, we can 
get--as a matter of fact, their last line, if I can quote from 
this, Mr. Chairman, if you will--``It is overall profits in 
Federal revenue, therefore it would not be affected.''
    Mr. Meyer. Are you talking about interest on reserves or 
interest on demand deposits? Interest on demand deposits would 
be a transfer from banks to businesses with no effect on tax 
    Mr. Rogers. Isn't that a static calculation? I am doing 
this for my own edification here. I am not trying to be 
    Mr. Meyer. It is very difficult to make an estimate of what 
the broader impacts of this would be on overall economic 
activity. What you are looking for is dynamic scoring, asking 
what other changes might occur in the economy and how that 
might generate additional income and tax revenue. That is a 
very difficult task to undertake. CBO did not make that 
calculation, and is not routinely made when estimating the cost 
of various programs.
    Mr. Rogers. I understand that. I guess my conclusion, or we 
will go back and do some of these as well, is if you can 
calculate the loss based on money for interest held in those 
accounts, you can also tabulate increased interest that 
previously was not taxed, and will be taxed just on those very 
simple calculations. We will play around with the numbers. I 
will be happy to talk with you.
    Mr. Hammond. We will be happy to work with you.
    Mr. Rogers. I think that $600 to $700 million is way 
overstated when you talk about total revenue generated. There 
is an old saying that money is neither created or destroyed. I 
have a feeling taxation falls in the same category here and we 
will find the way to get that money somehow.
    Thank you, Mr. Chairman. I would yield back.
    Chairman Bachus. Thank you. I will like to have the record 
reflect there is only a teddy bear remaining on the Minority 
side. And if it has no questions, we will go to Mr. Tiberi.
    Mr. Tiberi. I have no questions, Mr. Chairman.
    Chairman Bachus. Thank you.
    Mrs. Capito, no questions.
    Dr. Weldon.
    Dr. Weldon. I just have one quick question.
    Governor, you mentioned a lot of the machinations banks go 
through to keep their level of sterile deposits small with the 
Federal Reserve. You mentioned sweep accounts as one of them. 
What are some of the other things that they do?
    Mr. Meyer. Well, that is the major way that they reduce 
their required reserves. They take the deposits that are in the 
accounts that are reservable, and they find ways to transfer 
them into nonreservable accounts, preserving nevertheless the 
transactions' capability of the deposit holders, and that is 
what sweep accounts are all about. This is the major mechanism.
    Dr. Weldon. OK. I don't think I have any other questions. 
Thank you, Mr. Chairman. Thank you for your testimony.
    Chairman Bachus. Thank you.
    Governor Meyer and Secretary Hammond, if we were to offer a 
bill that required interest payments on required reserves and 
not on clearing balances or excess reserves, what would your 
reaction to that be?
    Mr. Meyer. Disappointment. We understand that there is an 
issue about paying interest on required reserves. There is 
budgetary cost, and you have a decision that has to be made 
about how to finance that or what to offset it with. But in the 
case of contractual clearing balances, that is really a switch 
from implicit to explicit interest. There is no budgetary cost, 
and I can't see any reason why you wouldn't do that. With 
respect to interest on excess reserves, it is something we 
don't really contemplate using today, and that would only be in 
our tool kit. Should we be in a position where we would want to 
change the way we implement monetary policy, it would be useful 
to have. But it is something for the future, not something we 
would plan to implement over any near term.
    Chairman Bachus. Thank you.
    Mr. Hammond. Yeah, I think what you would be doing is miss 
ing a large number of the benefits that could be obtained from 
paying interest on a broader universe of reserves.
    Mr. Meyer. Could I make one other point? We have suggested 
here that if we don't get interest on required reserves, we 
would be very anxious, nevertheless, to have a bill that gave 
us the opportunity to have interest on contractual clearing 
balances. That would help. And if we had both together, it 
might be possible over time to lower reserve requirements by 
having more funds flow into contractual clearing balances with 
explicit interest. It might allow us the opportunity to lower 
the actual required reserve ratio. So there is a real 
advantage, it seems to me, in a bill that has both interest on 
required reserves and interest on contractual clearing balance. 
And I would certainly hope you would support that.
    Chairman Bachus. I might ask both the first and second 
panel and the memberships they represent to look at the Kelly 
legislation, and you might suggest any changes in that as a 
result of that question.
    We have heard questions, and I think Ms. Hart was the one 
Member who asked some questions about maybe this is not in the 
best interest of the small banks, and I think maybe she 
recognized that there are small banks who oppose this, and I 
think we will probably, from the second panel, hear that some 
of their membership is divided, and at the same time in the 
past few years, organizations representing some of these same 
banks have asked the Congress to allow them to pay interest on 
business accounts.
    Having said that, there is a tangible cost to the banks of 
having to pay interest which they can pretty easily calculate, 
I would think. On the other hand, it is rather intangible on 
how much, how many deposits they are losing from not being able 
to offer that. Do you know of any estimates as to the costs 
thereof? We know that the deposit base on the smaller banks 
which don't offer sweep accounts, that base has been eroding 
somewhat, but do you have any thoughts on that?
    Mr. Meyer. No, I don't have any numbers to share with you, 
but it is certainly true that when community bankers come in 
and talk about their issues, funding issues are at the very 
top, and their ability to compete for what they call core 
deposits. These transaction accounts are very important to 
them, and of course, paying interest on demand deposits is one 
way for permitting them to be more competitive for those 
    Mr. Hammond. We are not aware of any estimates as well as 
to how you would, what the effect would be or what the deposit 
loss would be, or has been, to small financial institutions.
    Chairman Bachus. Thank you.
    Do any other Members have a follow-up question? Oh, Mr. 
Weldon have you, you have been--all right.
    At this time, we will dismiss the first panel. I will say 
that the Chair notes that some Members may have additional 
questions for this panel which they may wish to submit in 
writing, and without objection the hearing record will remain 
open for 30 days for Members to submit written questions to 
these witnesses and to place those responses in the record.
    At this time the first panel is discharged and I would like 
the members of the second panel to be seated, and thank you for 
your testimony.
    I would like to introduce the second panel at this time. 
From my left to right, Mr. James E. Smith is Chairman and Chief 
Executive Officer of Citizens Union State Bank and Trust in 
Clinton, Missouri, and President-elect of the American Bankers 
Association. We appreciate your testimony, Mr. Smith.
    Mr. David Bochnowski is Chairman and Chief Executive 
Officer of Peoples Bank of Munster, Indiana; Chairman of 
America's Community Bankers, and we appreciate your testimony 
and note, we also thank you for your service in Vietnam.
    And Mr. Thomas Jennings is Senior Vice President and 
General Counsel for First Virginia Banks on behalf of the 
Financial Services Roundtable based in Falls Church, Virginia.
    Mr. Jennings. Yes, sir.
    Chairman Bachus. And Mr. Robert Gulledge, President and 
Chief Executive Officer of Citizens Bank of Robertsdale, 
Alabama, who is here representing as Chairman of the 
Independent Community Bankers of America. And if any of you 
have never been to Baldwin County, Alabama, it is your loss. 
Mr. Gulledge, a beautiful, beautiful county.
    At this time, without objection, your written statements 
will also be made a part of the record. You will be recognized 
for five minutes to summarize your testimony, and we will start 
with you, Mr. Smith, and Mr. Bochnowski, I have allowed you an 
additional minute because you have extensive submitted 
    Mr. Bochnowski. Thank you, Mr. Chairman.


    Mr. Smith. Mr. Chairman, I would like to thank you for 
holding this important hearing. I would also like to 
acknowledge the continuing leadership of Representative Kelly 
on these issues, including sponsoring legislation to provide 
for 24 transaction sweep accounts, Federal Reserve flexibility 
on setting reserve requirements, and payment of interest on 
sterile reserves. We applaud her efforts and those of many 
Members of the subcommittee who helped move similar legislation 
through the House last year.
    We strongly support the legislative initiative underway in 
Congress that would authorize a new 24-hour transaction deposit 
account and allow the Federal Reserve to pay interest on bank 
reserve balances. I will briefly touch on each of these 
important issues.
    The banking industry has wrestled with the issue of paying 
interest on demand deposits for more than a decade. So far 
there is no consensus. However, there is broad industry support 
for creating a new account that will allow 24 transfers per 
month between a checking account and an interest-bearing 
account, that is one transfer for each business day. This is 
the concept contained in Representative Kelly's bill, H.R. 974, 
which we support. This new account will help banks meet the 
needs of their large and small business customers and better 
compete with non-bank firms, such as investment companies, 
security companies and credit unions that offer interest-
bearing business accounts. Some bills introduced over the last 
few years go beyond ABA's current position in that they will 
eliminate the prohibition on paying interest on demand 
deposits. If Congress does decide to take such action, it is 
critical that an adequate transition period be provided. Banks 
often provide a bundle of services to compensate for the 
prohibition on paying interest such as transaction services, 
lending and lines of credit, and other ancillary services. A 
transition would allow time to unwind these arrangements and to 
price explicitly these services or reset any previously agreed-
upon terms.
    My second point relates to interest on reserves held at the 
Fed. ABA supports authorizing the Fed to pay interest on 
sterile reserves. The opportunity cost of holding non-interest-
bearing reserves at the Fed has been significant over the 
years. Conservatively, we estimate the cost at $400 million 
this year. However, the cost to our communities are many 
multiples of this due to the additional foregone lending 
opportunities that would certainly arise. The high cost of 
sterile reserves naturally creates an incentive for banks to 
minimize this burden. The introduction of sweep accounts was 
one avenue to lower these costs. As a consequence, since late 
1993, reserve balances at the Federal Reserve bank have dropped 
from almost $30 billion to $6\1/2\ billion today. Simply put, 
required reserves held at Federal Reserve banks will continue 
to decline unless market interest rates are paid on these 
    Paying interest on reserves could help the Federal Reserve 
conduct monetary policy since it will allow the Fed to maintain 
reserves at whatever level it thought appropriate to achieve 
its goals. In addition, paying interest on reserves will 
facilitate the development of transaction deposit products and 
level the playing field between banks and other financial 
    Finally, let me address the budget issue that surrounds 
this bill. Some argue that paying interest would have a 
negative budget impact, but the ABA believes that without the 
payment of interest, reserves will vanish and so will the 
Federal revenues received. However, if interest is paid, the 
declining reserve will be stemmed and Federal revenues will 
increase from what they would have been. Simply put, the 
payment of interest will yield a budgetary gain over time.
    And in conclusion, the ABA strongly supports legislation 
that would authorize a new 24 transaction deposit account, and 
allow the Federal Reserve to pay interest on bank reserve 
    Thank you, Mr. Chairman, for this opportunity to appear 
before your subcommittee today.
    [The prepared statement of James E. Smith can be found on 
page 60 in the appendix.]
    Chairman Bachus. Thank you.
    Mr. Bochnowski.

                       COMMUNITY BANKERS

    Mr. Bochnowski. Thank you, Mr. Chairman. My name is David 
Bochnowski, and I am Chairman and Chief Executive Officer of 
Peoples Bank in Munster, Indiana. I am testifying today in my 
capacity as Chairman of America's Community Bankers on behalf 
of ACB. Thank you for this opportunity to testify on this issue 
of critical importance to community banks in small- and medium-
sized businesses across America.
    ACB strongly supports allowing banks the option of paying 
interest on business checking accounts as reflected in the 
legislation introduced today by Representatives Toomey and 
Kanjorski. We also strongly support authorizing the Federal 
Reserve to pay interest on sterile reserves, in fact, these 
issues were first brought to the attention of Congress by ACB 
in 1994, and they continue to be a top priority of ours.
    The ban on interest-bearing checking accounts is the last 
statutory vestige of Regulation Q, a Depression-era law that, 
in the words of Federal bank regulators, no longer serves a 
public purpose. Instead, this prohibition has resulted in an 
anti-competitive business environment that has allowed a 
limited number of financial conglomerates to corner the market 
for cash management services that continues to block off an 
entire area of potential deposits for community banks to lend 
to our neighbors and to our communities, and it prevents many 
small businesses from earning interest on their checking 
    The obvious solution to these problems is for Congress to 
pass legislation allowing banks the option of paying interest 
on business checking accounts, and in fact, just last year, the 
House passed such legislation not once, but twice. Both bills 
were passed with the support of ACB and the National Federation 
of Independent Business, the United States Chamber of Commerce, 
and a host of other organizations. During a speech before ACB 
last December, Chairman Greenspan singled out the detrimental 
effects of this prohibition saying, and I quote: ``This is of 
particular concern to community bankers, of course, given that 
larger banks are offering interest to their customers through 
sweep accounts. Bending legislation, modernizing the law would 
potentially help bolster deposit growth and open opportunities 
for other profitable customer relationships without the 
unproductive and costly circumvention of the existing 
    We are pleased Governor Meyer has echoed those remarks 
earlier in his testimony today. Given this broad coalition of 
support for repealing the ban, you may ask why this prohibition 
still stands. Historically, much of the opposition has been 
generated by a few large financial firms and banks. Unlike most 
community banks, these institutions can conduct sweep 
arrangements efficiently because they have the financial 
resources to do so.
    As the head of a $400 million community bank, I can tell 
you firsthand that for most of us, sweep arrangements are a 
costly and cumbersome product. We offer them because we don't 
have the option of paying interest on business checking 
accounts. And for many smaller community banks sweeps are not 
an option. The minimum investment for these types of 
arrangements is well beyond the reach of most small- and 
medium-sized businesses.
    Mr. Chairman, we understand that large banks and Wall 
Street financial firms have invested significant resources in 
offering sweep account services to their customers. We do not 
begrudge the benefits they have reaped from their efforts, nor 
do we oppose their continuing to conduct business in this 
manner. But we do not believe it is asking too much to ask 
Congress to allow community banks, many of us who are strapped 
for deposits, to compete in the marketplace for cash management 
    And what about small business customers that larger 
financial institutions do not serve? Doesn't it make sense for 
Congress to give them the option of earning a market rate of 
return on their deposits?
    We think the time has come to lift this artificial 
prohibition and keep more money on Main Street and off Wall 
Street. We are also well aware that some of our community 
banking brethren do not see eye to eye with us on this issue. 
Let me say to them that we do not support legislation that will 
require banks to pay interest on business checking accounts. We 
simply want the option for them to do so.
    Mr. Chairman, I would like to also express ACB's support 
for legislation authorizing the Federal Reserve Board to pay 
interest on sterile reserves held at Federal Reserve Banks. On 
behalf of ACB I would like to commend Representative Kelly for 
her ongoing efforts on this issue.
    Finally, there is the critical point of timing with respect 
to this issue. Because a delay would only postpone the benefits 
of this much needed change, it is our strong preference that 
legislation giving banks the option to pay interest on business 
checking accounts do so immediately upon enactment. We do 
recognize that some institutions are seeking an extensive 
transition period. While we appreciate the efforts made by 
Representatives Toomey and Kanjorski to accommodate these 
concerns, we strongly believe a phase-in period is unnecessary 
and undesirable.
    ACB strongly endorses the Toomey-Kanjorski bill as an 
important step in allowing banks to offer interest-bearing 
checking accounts. We commend House Financial Services 
Committee Chairman Oxley for putting this issue on the fast 
track, and we commend you, Chairman Bachus, for holding today's 
hearing. Thank you again for the opportunity to testify before 
the subcommittee, and I look forward to any questions you might 
    [The prepared statement of David A. Bochnowski can be found 
on page 69 in the appendix.]
    Chairman Bachus. That was a 5-minute statement.
    Mr. Bochnowski. Thank you, Mr. Chairman.
    Chairman Bachus. Mr. Jennings.


    Mr. Jennings. Thank you, Mr. Chairman. I am the General 
Counsel of First Virginia Banks, Inc., in Falls Church, 
Virginia. I am pleased to have the opportunity today to speak 
on behalf of the Financial Services Roundtable. First Virginia 
is the oldest bank holding company in Virginia, with roots 
beginning in 1949. The Financial Services Roundtable represents 
100 of the largest integrated financial services companies 
providing banking, insurance and investment products and 
services to American consumers. Roundtable member companies 
account directly for $17 trillion in managed assets and $6.6 
trillion in assets and provide jobs for 1.6 million employees.
    Chairman Bachus, thank you for holding this hearing today 
and for inviting the Roundtable to participate. The Roundtable 
also extends thanks to Congresswoman Sue Kelly for introducing 
H.R. 974, which will be the focus of my testimony.
    The Roundtable strongly supports this bill and it would 
help to remove the hidden tax imposed on banks by allowing the 
payment of interest on banks' required reserves.
    The Roundtable strongly believes that any bill that allows 
institutions to pay interest on commercial checking accounts, 
such as the bill introduced by Congressman Pat Toomey, must be 
coupled with provisions allowing the Federal Reserve Board to 
pay interest on required reserves. The reason for this is 
simple. If institutions are to begin paying interest on 
commercial checking accounts, they will be forced to undertake 
significant changes in operating systems and, more importantly, 
they will be pressured to revisit their pricing for numerous 
account relationships.
    Non-interest bearing, or sterile reserves held at the 
Federal Reserve, amount to a hidden tax on banks. This 
nonproductive use of deposits runs counter to the interests of 
all of our key constituencies, including our bank's management, 
shareholders and, more importantly, our customers and our 
communities. Reserve requirements make banks less likely to 
develop new and innovative deposit products since the cost of 
these products are artificially high.
    Let me explain how the bill which will permit the payment 
of interest on business checking will affect First Virginia. 
Currently our family of banks meets all of its reserve 
requirements through vault cash, the money we keep in branches 
and at other facilities, and through required balances held at 
the Federal Reserve. First Virginia has a program in place to 
aggressively manage the cash we hold and where we hold it in 
order to ensure that our customers receive cash when they need 
it. Because banks our size must hold 10 cents in reserve for 
every additional dollar held in checking accounts, allowing the 
payment of interest on business checking accounts would 
increase the amounts held in those accounts, thus substantially 
increasing our reserve requirements. The corresponding increase 
and required reserves may force us to hold excess cash over and 
above the amount we need to pay our customers. If First 
Virginia were to carry this money without receiving interest on 
it or without being able to put it to productive use, it could 
increase the hidden cost paid by our institution. If the 
Federal Reserve were to pay First Virginia and other banks 
interest on the reserves kept with them, the cost of holding 
these excess reserves would at least be partially offset.
    I would also like to point out a possible unintended 
consequence if a policy change results in banks holding 
additional non-interest-bearing reserves. Because an increase 
in these reserves would make it more expensive to banks to 
offer checking accounts, many consumers might choose to place 
their money in accounts outside the banking system. The end 
result might be that the Federal Reserve would hold even fewer 
reserves, because banks would be holding fewer deposits.
    In the past, Congress has linked the issue of paying 
interest on required reserves with paying interest on 
commercial checking. In 1998, the House Banking Committee 
included both provisions as part of its broader regulatory 
relief package, as championed by Congresswoman Roukema. That 
bill, H.R. 4364, passed the House by voice vote.
    As the subcommittee has already heard, strong monetary 
policy arguments exist for allowing the Federal Reserve to pay 
interest on required reserves.
    Mr. Chairman, in conclusion, the Roundtable appreciates the 
opportunity to provide our comments and supports this important 
legislation that would remove the hidden tax on banks and urges 
Congress to follow its historical practice of combining payment 
of interest on reserves legislation with interest on commercial 
checking legislation. Thank you again for the opportunity, and 
I would be pleased to answer any questions.
    [The prepared statement of Thomas P. Jennings can be found 
on page 75 in the appendix.]
    Chairman Bachus. Thank you, Mr. Jennings.
    Mr. Gulledge.


    Mr. Gulledge. Good afternoon, Chairman Bachus, Ranking 
Member Waters and Members of the subcommittee. My name is 
Robert I. Gulledge and I am Chairman, President and CEO of 
Citizens Bank, a community bank of $82 million in assets 
located in Robertsdale, Alabama. I also serve as Chairman of 
the Independent Community Bankers of America, on whose behalf I 
appear before you today.
    I want to thank you for giving me the opportunity to 
testify and I want to congratulate you, Chairman Bachus, on 
your elevation to the Chair of this important Financial 
Institutions Subcommittee of the Financial Services Committee.
    I will first address the issue of paying interest on 
business checking accounts. Mr. Chairman, as you know, 
repealing the ban on paying interest on business checking 
accounts has been hotly debated among community banks for many 
years. Community bankers continue to be sharply divided on this 
issue. Proponents of lifting the ban argue that it would 
increase economic efficiency, simplify business practices and 
help them keep their best business customers. Opponents argue 
that lifting the ban would squeeze their margins and impose a 
financial burden on them that could jeopardize their ability to 
compete for business customers in their markets.
    In my written testimony I describe the impact this proposal 
would have on two different banks, one in favor of lifting the 
ban and one opposed. The banker who opposes lifting the ban 
from a $721 million assets bank on the East Coast calculated 
that he would have to raise more than $21 million in additional 
deposits just to offset the interest costs if he were forced to 
pay interest on his business checking accounts. This cost, he 
said, would be prohibitive.
    The banker who supports lifting the ban from a $161 million 
asset bank in the Midwest feels that the current prohibition 
has been competitively damaging to his bank and to others. He 
argues that brokerage firms and other non-bank competitors have 
moved aggressively to compete with commercial banks for small 
business relationships, and without the tools to compete, banks 
and others could lose some of their best commercial accounts.
    Mr. Chairman, because bankers are split on this issue and 
the feelings run strong on both sides, the ICBA has advocated a 
compromise, that bankers on both sides tell us they can 
support. Under this compromise the number of allowable 
transactions from money market deposit accounts would be 
increased to 24 per month from the current legal limit of 6 
while keeping the permanent prohibition in place. This 
alternative was proposed in legislation introduced by 
Representative Kelly last year. It would allow banks to sweep 
funds between non-interest-bearing commercial checking accounts 
and interest-bearing money market deposit accounts on a daily 
basis. Thus, banks would not be forced to offer interest on 
commercial checking accounts but, rather, would have the option 
of paying interest on their commercial checking accounts by 
using sweep mechanisms.
    Mr. Chairman, this is the only alternative that we are 
aware of that has not raised objections from one side of the 
issue or the other side of the issue. We urge you and the 
subcommittee to give this proposal serious consideration, and 
we stand ready to work with you on this compromise. If you 
determine to go forward with removing the ban, may I suggest 
you allow an appropriate time to dismantle existing contractual 
arrangements of existing accounts with our customers.
    Let me now turn to the issue of allowing the Federal 
Reserve to pay interest on sterile reserves. We have no 
objection to this proposal, even though it is not an issue that 
would affect most small banks directly. Most small banks have 
transaction deposits in the lower tranche and are either not 
required to maintain reserves or can meet their reserve 
requirements with vault cash. In my written testimony I 
describe in greater detail the effect that this proposal would 
have on a typical ICBA community bank.
    Thank you for the opportunity to testify. I would be happy 
to answer questions you or the subcommittee may have. Thank you 
very much.
    [The prepared statement of Robert I. Gulledge can be found 
on page 80 in the appendix.]
    Chairman Bachus. Thank you, Mr. Gulledge.
    At this time we will recognize Mr. Cantor for 5 minutes.
    Mr. Cantor. Thank you, Mr. Chairman. And I guess any of 
panelists could probably answer my question. It is really for 
my own knowledge in trying to understand sort of the costs 
associated with the sweep accounts arrangements, and I hear 
some of you advocating a long transition period so you can 
unwind and get rid of the costs associated with them. Is there 
any other reason for these sweep arrangements other than to, if 
you will, get around the prohibition on interest checking for 
demand deposits for business?
    Mr. Bochnowski. Congressman, we introduced the sweep 
accounts this past August. We now have $10 million worth of 
deposits, if you want to call them that, that have been 
attracted to these accounts. Of that $10 million, only 6.5 
percent comes from inside the bank. We have existing 
arrangements with some of our customers; therefore, they are 
not eligible for these accounts. So while we do not have the 
option of doing what we would like to do with business 
checking, we have still figured out a way to do it, and it is 
costly. The requirements that we have to come back to our 
customers with, which is to, on a daily basis, monitor the 
level of these repurchase agreements of Government securities 
and to inform our customers daily of the value of those 
Government securities. So there is tremendous cost involved. 
So, from our point of view, we would rather go ahead and let 
this option run to all banks and let each bank on its own in 
the free market decide how it wants to offer those products to 
their customers.
    Mr. Smith. I want to give you an experience in my bank. A 
little over a year ago, we succumbed to the sweep accounts and 
started offering the sweep accounts. I would tell you that 
today we have picked up about 4 percent additional deposits if 
I was able to keep those deposits in the bank. Those are 
outside deposits. But I do have the third party provider that 
takes care of the sweep operation for me and I am under a 
contractual arrangement to continue with that for a period of 
time. So at my particular bank, I would need some time to 
unwind from that contractual relationship.
    Also, for a number of my commercial accounts it has been 
years building up, what we call bundled services, whether it is 
below market interest rates on loans or purchasing their checks 
or offering them other incentives because we cannot pay 
interest on their corporate account. That is going to take some 
time to go back and work with those accounts and work out those 
arrangements so we can make it an equitable situation both for 
the corporate customer and for the bank.
    Mr. Jennings. Not only are there costs involved in the 
sweeps, but we found that our business customers sometimes have 
a hard time keeping up with what is going on and the smaller 
business customers especially have had problems maintaining 
enough staff to look at what we are giving them in the way of 
what we have done for them. So there are not only costs to us, 
but costs to our customers if they are doing that.
    Mr. Gulledge. I do not have sweep accounts in my bank, and 
obviously if this legislation--if this ban is removed, this is 
a service that I will have to provide to be able to be 
competitive and to provide the service. I am a practicing 
banker and I am going to provide the services that are demanded 
of my customers. But there are also contractual arrangements 
out there dealing with loan customers, conditional loan 
approvals, compensating balances, there is a lot of other 
things that are out there that would have to be dealt with, and 
it is not something that I think can be made effective 
immediately without having serious effect on the operations and 
the performance of banks.
    Mr. Cantor. Mr. Chairman, I yield back the balance of my 
time. Thank you.
    Chairman Bachus. Thank you, Mr. Cantor.
    Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman.
    There is some disagreement it appears among the panel over 
the timing of how quickly sweep accounts or how quickly an 
interest on deposit should be allowed, whether there should be 
a one-year transition or a two or three-year transition period. 
And I guess, Mr. Smith, I just heard you--I kept getting paged, 
so I apologize I had to keep getting up--but I heard you say 
you have a contractual--in your own instance, you have 
contractual arrangements with a provider that requires you to 
work with them for a certain amount of time. I guess my 
question is do any of you all know what the average length of 
the sweep arrangement contracts are? It would seem to me that a 
lot of these are a year or less and would be fairly flexible to 
get out of. Maybe that is not the case.
    Second of all, Mr. Gulledge, I wonder with respect to your 
members in particular, I understand there are some members who 
would not, smaller banks where it would be cost prohibitive to 
establish perhaps your own system of setting up interest 
payments, whether you were going to hedge or what not. But 
there is a ready market already there offering money market 
demand accounts. The banks are using them as it is. Why 
wouldn't your banks want to use that at a nominal fee for the 
benefit of their customers?
    Mr. Gulledge. Well, in the written testimony I have given 
you the example, as I alluded to, of the two banks, one that 
was a $721 million bank that said he would have to develop a 
$21 million deposit growth to compensate for the cost and yet 
another at $161 says that he needs it to be more competitive. 
And I think what we are really saying here is that every 
community bank is going to have to look at their market, they 
are going to have to look at their competition, they are going 
to have to take a look at their customer base. There is a lot 
of work, and here again this is another reason, in my opinion, 
for giving a period of time in working out the proper 
arrangement so that every bank can look at it and make their 
own decisions as to what can be profitable.
    Mr. Smith. I don't know that there is any specific--I don't 
know the numbers--if there was any time that it would take, the 
average time to eliminate the sweep accounts, but please keep 
in mind it is not just the contractual relationships on the 
sweep accounts. Maybe I've quoted a loan at a below market rate 
because of the compensating balances and that might be a five-
year loan. So I have already committed to a loan customer on 
one side of the ledger and then I want to at least try to 
average it out so I can come out on the other side of this 
issue. So perhaps I purchase their checks. Some of these checks 
are expensive, maybe $4-$5,000 for a two-year supply of checks. 
So what we are trying to do is balance this so we can make this 
transition period as smooth as possible for the banks to work 
into this. And it is voluntary, so in some of these 
arrangements you may want to continue the way you have been for 
a period of time until you can handle it.
    Mr. Bentsen. I don't completely understand what you are 
saying. Are you saying that in some of your arrangements that 
you have with your commercial clients that you have offset some 
of your cost or you have hedged some of the benefits you are 
providing with your customer with the rate you are getting 
through the sweep account? So it is not just a question of 
getting out of the sweep account, it is other costs that are 
factored into that as well?
    Mr. Smith. That is correct. It is a whole bundle of 
services that we have been trying to provide to our corporate 
customer in lieu of paying them interest on their checking 
    Mr. Bochnowski. We all have these contractual arrangements, 
yet they don't have to hinder the small business side of this. 
I don't know that we should ask them to wait, especially since 
our experience has been that we do bring funds from outside the 
banking system into the banking system when we offer a product 
that is akin to this, the sweep accounts that we now have. The 
time that it would cost any of us to let our existing 
relationships run off: that is on our side, but there are many 
bankers who have not chosen to take the steps that we have. And 
we will ask them to wait until we can solve our problem in 
order for them to be able to offer this business checking 
option that we would like to have to their customers. And I 
think it is fair to say that we shouldn't ask the rest of the 
banking industry to wait while we catch up.
    Mr. Bentsen. Mr. Chairman, I sort of agree with that 
viewpoint, but I guess obviously you make an arrangement with 
your clients and you put together a package that is both 
beneficial to your client or obviously they would not be there, 
and beneficial to the bank and stockholders, because you are 
ultimately in the business of making money, which is a good 
thing. But I think that Mr. Bochnowski is somewhat correct 
that--I mean, we can't stop the clock if we are going to try to 
continue to deregulate the banking industry, which is the next 
step to do that.
    Mr. Smith. I would only say that this is voluntary so 
nobody has to wait. If they want to offer the 24 transfer, that 
is the same thing and so nobody has to wait. They can offer 
that product. And I may want to continue to offer my sweep 
products instead of offering the 24 transfer.
    Mr. Bentsen. But overall deregulation would be put off for 
two or three years on some of the bills that are being 
considered, and I think that is an issue that we have to think 
long and hard about.
    Thank you all.
    Thank you, Mr. Chairman.
    Chairman Bachus. Thank you, Mr. Bentsen.
    Mr. Toomey.
    Mr. Toomey. Thank you, Mr. Chairman.
    I would just like to follow up on the issue of the 
voluntary nature of this, because I spent many years as a small 
business owner and I have had accounts with banks and I have 
run into all of these arrangements, or at least a number of 
arrangements that have been alluded to, whereby I have had a 
loan where the interest rate charged to me on the loan was 
contingent on a certain balance that I would not earn interest 
on. It strikes me if you got such a loan on the books you could 
leave it exactly as it is, because this bill would not require 
paying interest on those deposits; it would simply provide the 
    Similarly, I remember going through stacks of my bank 
statements that were very complicated and very lengthy to total 
up all of the little credits against service charges that I was 
being given, again in sort of compensation for the average 
balance that I have left. And again, it seems to me that is 
something that could continue. I don't know why anyone would, 
but you could continue it. So I guess from the point of view of 
the corporate borrower or your customer in that sense, I am 
wondering if I am missing anything. Are there other kinds of 
transactions where, absent a long phase-in, you would really 
have a contractual problem, or could you not continue with the 
current arrangement as a practical matter with respect to most 
of your customers? Maybe not with your correspondent banking 
relationship whereby you have the sweep accounts, but with 
relationship to the customers. Am I missing categories of 
transactions or something?
    Mr. Smith. I can only give you the experience of my bank. 
It is a rural bank in mid-Missouri and most of my arrangements 
with compensating balances are implied arrangements. They are 
not written arrangements. And basically it is discussions and 
knowing my customers for the past 27 years that I have dealt 
with them. I just need some time to work with them, educate 
them that we are unbundling, listing this service. We are going 
to be paying interest on their account if they so desire, but 
at the same time we will be doing some other things on the 
other side of the ledger that may be charges to them. I don't 
have necessarily very many contractual relationships that say 
you have to keep a six figure balance in order to get this 
interest rate on your loan. It is more of an implied number, 
just from my knowledge and history of what this business has 
done in the past.
    Mr. Toomey. In your case, if you had one year for this 
change to take place, would that give you enough time?
    Mr. Smith. I still have a contractual relationship with a 
third party vendor out there that is going to go two years, so 
I've got to take care of him. So obviously we have got to meet 
my contractual relationship.
    Mr. Toomey. OK. I had another question for Mr. Bochnowski 
and I was wondering if you could share for us, I expect a lot 
of Members are not familiar with what a repo is and the 
mechanics and costly nature of trying to create this 
transaction as the way to circumvent this archaic rule. I was 
wondering if you could share with us how and why it is really a 
pain in the neck.
    Mr. Bochnowski. I appreciate that opportunity, Congressman. 
It is transparent to the customer, but on the bank side 
literally what we have to do is the customer's large deposit, 
instead of going into a checking account goes into a repurchase 
agreement; that is to say, they take a security interest in 
Treasury bills that we already own. And we are required by bank 
regulation when we do that--and since that is outside the 
depository relationship funds can sweep between their checking 
accounts and that account numerous times a day without 
violating any existing rule. But, because of the nature of the 
banking rules on this issue, we are required--first of all, we 
cannot pledge more than we have, so we have to monitor that 
security on a day-to-day basis, or those securities that are 
bundled on a day-to-day basis to be sure that we haven't 
exceeded regulatory requirements there. Second, because it is a 
repurchase agreement, again under requirement, we must tell the 
customer every day what the value of that security is. So we 
are forced to do a lot of bureaucratic transactions at a fairly 
substantial cost in order to reach a result to get around the 
law and to provide a transparent result to the customer.
    There is also a practical consideration here. At a bank our 
size, which is $400 million, we might have a securities 
portfolio on any given day of $40- to $50 million. Some of that 
is held for sale and some of that is our permanent portfolio. 
We can only attach this product to the permanent side of the 
portfolio. And so that we might be limited--there is a finite 
point at which we can no longer offer this service within our 
community because we run out of securities. If we have to wait 
for a year or two or three years, there again, I am going to 
say to my customers or people who have the potential to bring 
money back into the banking system, ``This is a great product, 
but could you wait ten or twelve months until I get back to 
you?'' I do not think that is necessarily good for our bank, I 
do not think it is good for our community, and I do not think 
it is good for our small business customers.
    Mr. Jennings. Technically that is a sale of securities by 
the financial institutions to the customer with an obligation 
or a commitment to repurchase those securities at a certain 
interest rate. And as my colleague over here said, there is 
only a limited number of securities that banks hold in their 
portfolios. So these are Federal Government securities and 
there is a limit to how much that is, so you can't offer that 
to anybody.
    Mr. Toomey. And they have to be marked to market daily and 
it strikes me as a rather cumbersome process as opposed to 
paying 4 or 5 percent interest.
    Mr. Smith. Correct.
    Mr. Toomey. Thank you. I yield back the balance of my time.
    Chairman Bachus. Thank you.
    Ms. Hart, do you have any questions?
    Ms. Hart. Thank you, Mr. Chairman.
    I did ask a question of the earlier panel that I don't 
think I need to ask again of this panel. Your testimony is all 
pretty clear. I think the one disagreement that I would like to 
get a little bit more of a handle on, or I guess some of you 
have been noncommittal, is the amount of time we ought to take, 
if any, to phase in the interest on business checking. The 
first panel clearly doesn't want any time to really be spent on 
a phase-in. I would just like each of you to comment on what 
you think would be the ideal amount of time for us to take 
until that is phased in, if it is phased in, or if we do it 
    Mr. Smith. The bill that passed the House last year had a 
three-year phase-in and the American Bankers Association 
supported that bill, and that would be our position today.
    Mr. Bochnowski. America's Community Bankers would like to 
have it phased in immediately, because this is an option. We 
think that every bank could, at its own pace, decide when it 
wanted to phase it in and they could take that approach. I 
think the problem with the phase-in is you get the result, but 
you have a cumbersome process, because you have to go from 
money market accounts to the checking accounts. You have a 
double set of accounts you have to keep track of. You have a 
double set of regulations you have to watch. Why not just do 
it? If we are going to do it, let's do it.
    Mr. Jennings. Our members have incurred, a lot of them 
anyway, have incurred substantial costs in putting into place 
existing systems that they have. On the other hand, our members 
probably can afford to make the transition a lot easier than 
some of the other institutions could. So we did not take a 
position one way or the other on this, but we would not be 
opposed to whatever the subcommittee does up to a three-year 
    Mr. Gulledge. The differences that you are hearing between 
this panel and the other panel is that we are--for the most 
part, we are the practicing bankers and we are the ones that 
will be affected by the transition period, and I would say at 
that point as a minimum we need a three-year transition period.
    Mr. Hart. Thank you for that. So there isn't complete 
agreement, and that is OK.
    The other issue is the one that I had asked about earlier, 
was a question about pressure on the banks, and I think I want 
to direct this actually to community banks, because you are 
smaller to begin with, and the question that I had was is there 
any reservation in the back of your mind about the pressure 
that might be exerted upon your bank to compete in a market 
with a lot fewer resources and to offer interest even though it 
is not mandated by this law and even though your members or you 
may not feel that it is the wisest thing to do in order to stay 
even in business? Does that thought enter your mind or is that 
something you have heard from many of the members of the 
    Mr. Smith. I could respond. With my bank, personally, as I 
said, I started sweep accounts about a year ago and I have 
about $6.3 million in those sweep accounts and that is money 
that was going outside the community from local businesses and 
corporations. It was going outside the community. And I am glad 
I started it because I found some funding that I would like to 
get back into the community. If we do the 24 transfer 
legislation, then that will give me the opportunity to handle 
some of the liquidity problems in my community, my bank.
    Mr. Bochnowski. Congresswoman, I don't see that as an 
issue. I think we are under pressure right now to compete in 
our marketplace for all kinds of deposits and all kinds of 
products and services. I started in this Roundtable community 
of banks back in 1976 and I think the Federal Reserve 
statistics are that, at that point 90 percent of all deposits, 
all domestic deposits were at passbook or less in the United 
States of America. Times have changed. Clearly regulators also 
look at something called interest rate risk. They have to watch 
us very carefully at the behest of Congress on those kinds of 
issues. I think that the industry has proven that it can deal 
with these issues. And I think that we--Jim's company is 
currently offering this product. We are, too. I think we are 
doing it prudently. I don't think we are giving away the store 
at all.
    Mr. Jennings. The 24 sweep issue is--obviously our 
preference is to have interest on checking and interest on 
sterile reserves linked together. That is preferable. I can 
remember back to 1978 when the interest was allowed first to be 
paid on consumer checking accounts and it did not start out as 
interest on checking accounts. It started out as interest on 
savings accounts, which you could sweep into checking to pay 
the checks that came in, and only after a period of time did we 
go to NOW accounts and allowing interest on NOW accounts. In my 
own view, that is just people realize that is what the market 
is and that is the way things ought to be. So the 24 sweeps, I 
think if we went that route it is just temporary and eventually 
we would go to the market rule, which is paying interest on the 
funds that you have that belong to somebody else.
    Chairman Bachus. Thank you, Mr. Jennings.
    Mrs. Kelly.
    Ms. Hart.
    Ms. Hart. Mr. Chairman, I just realized that my time was 
up. Thank you.
    Chairman Bachus. Thank you.
    Mrs. Kelly.
    Mrs. Kelly. Thank you, Mr. Chairman.
    Mr. Smith, can you tell me the percent of accounts that are 
business checking accounts at your bank?
    Mr. Smith. Probably 35 percent business checking accounts, 
and I have some accounts classifieded as ag loans or ag 
accounts that would be approximately another 3 or 4 percent, 
because they are incorporated. So somewhere between 35 and 40 
    Mrs. Kelly. Thank you.
    Mr. Bochnowski, can you tell me what percent of accounts 
you have in your business checking accounts in your bank?
    Mr. Bochnowski. It fluctuates, but I would estimate it is 
20 to 25 percent.
    Mrs. Kelly. That is considerably less than Mr. Smith holds 
in his bank. So would I be wrong in assuming that you see the 
repeal of the prohibition of paying interest on business 
checking as a way that you can attract a greater number of 
business deposits in your bank?
    Mr. Bochnowski. I think that has something to do with it. I 
think there is also a little bit of history. While we are 
currently chartered as a State bank under Indiana law, we 
started as a thrift. Our company is 90 years old. We haven't 
been able to have business checking accounts for--except for 
the last probably decade--ten or fifteen years.
    Mrs. Kelly. Mr. Bochnowski, your testimony did not address 
the issue of giving the Fed greater flexibility in setting the 
reserve requirements. Do you have a position on my legislation 
    Mr. Bochnowski. We are in favor of your legislation there.
    Mrs. Kelly. Thank you. Also in your testimony you said that 
sweep activities are a costly and cumbersome product. I find 
this a little bit confusing, because I have a copy of a report 
in my hand here, it is Service and Product Solutions for 
Community Banks, which it says on the masthead, ``Brought to 
you by America's Community Bankers.'' And on page six of this 
ACB publication it says--and I can read it or you can see it, 
and I have done my homework here, and underscored it: ``The 
banks utilizing sweeps are finding that they are strengthening 
existing customer relationships as well as benefiting from 
obtaining new bank clients. A bank sweep account in a focused 
marketing plan represents a serious advantage in expanding and 
acquiring new business relationships, which can be extended 
into other banking opportunities.''
    It just seems very interesting to me that you would give 
such different testimony from what the ACB writes in its own 
    Mr. Bochnowski. I don't disagree with what is said there. 
When I say they are costly, I mean it in this sense, 
Congresswoman. The threshold for our sweep accounts is $50,000. 
We cannot start our business customer until they get to that 
level. We would like to have it be much lower. We would like to 
see it at the $10- or $15,000 level, depending on their 
relationship with the bank in other ways, as has been alluded 
to in this testimony. But I think when I say they are costly, 
it is simply because they are, and that we cannot start the 
process of entering the customers into the sweep accounts until 
they can reach a certain deposit threshold level.
    Mrs. Kelly. Thank you very much. I yield back the balance 
of my time.
    Chairman Bachus. Thank you.
    Mr. Rogers.
    Mr. Rogers. Thank you, Mr. Chairman.
    Mr. Smith, you mentioned a point earlier that caught my 
attention. You said that--and maybe I misunderstood you--if we 
move the date up it would cause some liquidity problems for the 
bank. I assume that is because of the contractual relationship 
you have with your large corporate accounts. Can you help me 
understand that?
    Mr. Smith. No, I don't believe that is the way I intended 
that to sound. I think if we moved the date forward I think it 
will be difficult for the banks that are under contractual 
relationships to unhook from those relationships and unbundle 
those services quickly. And I think it will cost them some 
money on the bottom line in trying to meet that timeframe and 
move into the other timeframe. I didn't mean it from a 
liquidity standpoint, from a lending framework. I just meant 
that it would cost some of those banks some money on the bottom 
line in order to unbundling this program and starting a new 
program at the same time.
    Mr. Rogers. Can you give me an example of some kinds of 
activity you would want to unbundle and leave off the table in 
lieu of paying interest?
    Mr. Smith. For instance, I will go back, if we have 
purchased checks for this corporation, if we were going to pay 
interest on their checking account in the future we would not 
be interested in purchasing their checks and being out that 
expense. If we were going to tie it to compensating balancing, 
their loan rates--if we are going to tie that to compensating 
balances, then we won't be as interested in giving them such an 
advantageous program, if we are going to be paying them out on 
the other side of the ledger, because we have to balance the 
income and expense accordingly. So that is basically what I was 
driving at when I indicated we would have to unbundle some of 
these services and we would need time to get that accomplished 
as we move into this transition.
    Mr. Rogers. I appreciate that. I relayed a story earlier to 
Congresswoman Kelly that I was in a very rural, very small town 
in Michigan yesterday, having a meeting completely separate 
from this issue, and the local community bank closed its doors 
and walked down in total to that meeting to tell me to support 
this particular issue. I want to congratulate Congresswoman 
Kelly. If this can have that kind of a profound impact on a 
community that needs all the help it can get, I will be with 
    With that, Mr. Chairman, I yield back the balance of my 
    Chairman Bachus. Thank you.
    In addition to the witnesses that have testified before us 
today, the subcommittee has received written submissions from 
the United States Chamber of Commerce, the National Federation 
of Independent Business, the Association of Financial 
Professionals and the Community Bank Coalition, and their 
written submissions will become part of the record without 
    [The information can be found on page 85 in the appendix.]
    Chairman Bachus. And some Members may wish to submit to the 
panel, both the first and second panel, written questions, and 
with unanimous consent I am going to ask that the record be 
held open for 30 days to permit Members to submit those written 
questions to you and for you to respond back and allow them to 
introduce your responses into the record. So if they do make 
written requests of you, I hope that they will do so promptly 
and that you all will respond so that they may introduce those 
within 30 days. Obviously if they get them to you 3 weeks from 
today it may be tough.
    Mr. Jennings. I will be glad to answer any questions.
    Chairman Bachus. Thank you.
    With that, we thank you for your testimony. The second 
panel is discharged, and the hearing is adjourned. Thank you.
    Mr. Jennings. Thank you, Mr. Chairman.
    [Whereupon, at 4:28 p.m., the hearing was adjourned.]

                            A P P E N D I X

                             March 13, 2001