Truth in Savings; Proposed Regulatory Amendment

FEDERAL RESERVE SYSTEM

12 CFR Part 230

[Regulation DD; Docket No. R-0812]

Truth in Savings; Proposed Regulatory Amendment

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Withdrawal of proposed rule.

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SUMMARY: The Board is withdrawing proposed amendments to Regulation DD

(Truth in Savings) to provide for an additional formula to calculate

the annual percentage yield (APY), based on considerations of cost and

regulatory burden at this time.

DATES: This proposed rule is withdrawn May 4, 1994.

FOR FURTHER INFORMATION CONTACT: Jane Ahrens, Senior Attorney, Kyung

Cho, or Kurt Schumacher, Staff Attorneys, Division of Consumer and

Community Affairs, Board of Governors of the Federal Reserve System, at

(202) 452-3667 or 452-2412; for questions associated with the

regulatory flexibility analysis, Gregory Elliehausen, Economist, Office

of the Secretary, at (202) 452-2504; for the hearing impaired only,

Dorothea Thompson, Telecommunications Device for the Deaf, at (202)

452-3544.

SUPPLEMENTARY INFORMATION:

(1) Background

The Truth in Savings Act (12 U.S.C. 4301 et seq.) requires

depository institutions to provide disclosures to consumers about their

deposit accounts, including an APY on interest-bearing accounts. The

law also contains rules about advertising deposit accounts, including

accounts at depository institutions offered to consumers by deposit

brokers. The act is implemented by the Board's Regulation DD (12 CFR

part 230), which became effective June 21, 1993. (See final rule

published on September 21, 1992 (57 FR 43337), correction notice

published on October 5, 1992 (57 FR 46480), and amendments published on

March 19, 1993 (58 FR 15077).

In its initial rulemaking, the Board was guided by several general

principles, such as establishing simple rules that minimize the

possibility of errors and compliance costs and providing institutions

with flexibility to promote a variety of product choices for consumers.

This included designing a simple, easy-to-use formula for calculating

the APY. As deposit brokers and institutions began complying with the

new formula, the Board was asked by the Securities Industry Association

(SIA) and others to reconsider how the APY is calculated. Proposed

amendments that would provide for an additional APY formula were

published on December 6, 1993 (58 FR 64190).

The difficulties associated with the current APY formula stem from

the formula's assumption that interest paid on an account remains on

deposit until maturity. For some accounts, the formula produces an APY

that reflects the time value of interest received.1 For others the

APY fails to reflect the time value of interest received. This happens

in cases where institutions offer long-term certificates of deposit

(CDs) that are noncompounding but pay interest periodically. In this

case, the formula produces an APY that is less than the contract

interest rate.2

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\1\For example, assume $1,000 is deposited in a one-year CD with

a 6% interest rate that compounds quarterly. Consumers have the

option to receive quarterly interest checks instead. In both cases,

the APY is 6.14%, even though the consumer who compounds interest

receives $61.40, and the consumer who takes quarterly interest

checks receives $60.00.

\2\For example, assume $1,000 is deposited in a two-year

noncompounding CD with a 6.00% interest rate. Some institutions may

offer the consumer the choice of receiving all interest ($120) at

maturity, or receiving two interest payments ($60) each year. The

APY in either case is 5.83%--lower than the 6.00% interest rate--

because the formula looks at the total amount of interest paid, not

when it is paid out. The SIA states the maturities of CDs purchased

through deposit brokers range from three months to 10 years but

average about two years (based on dollar-weighted maturities).

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In considering whether to propose amendments to the APY formula,

the Board focused on two issues: a desire for an APY that reflects the

time value of money, and a concern about the compliance costs and

impact on depository institutions if changes were made. The Board

published a proposal that would factor into the APY calculation the

specific time intervals for interest paid on the account--that is, the

time value of money (Approach A). However, the Board also requested

comment on a narrower approach that would affect only noncompounding

multi-year CDs that pay interest at least annually. For these accounts,

the APY would never be lower than the interest rate (Approach B). The

Board also solicited comment on leaving the regulation unchanged

(Approach C).

The Board received about 500 comments on its proposal. Nearly 90%

of the comments were from financial institutions. Considering all

comments received, approximately 5% supported Approach A; 15% supported

Approach B; and 75% supported Approach C. The remainder presented other

alternatives or expressed no opinion on the specific approaches.

(2) Discussion

Approach A: Proposal of an Additional Formula

Based on the comments received and upon further analysis, the Board

is withdrawing the proposed amendments to the APY formula. Overall, the

Board believes that the proposed formula (Approach A) would be complex

and costly to implement, and the costs would outweigh the benefits

derived from the proposed changes. (See Docket R-0836 elsewhere in

today's Federal Register for proposed amendments which the Board

believes might better capture the intent of the act's purposes in a

less complex way.)

The Board believes the formula proposed in December would correct

the APY anomalies produced by the current formula, and has considered

the view of some commenters that the short-term costs of correcting the

formula might be worthwhile over time. However, the Board is more

persuaded by the commenters--including both consumer groups and

industry associations--that believed the costs of compliance outweigh

the benefits from implementing the proposed APY formula. Commenters

reported that substantial costs recently had been incurred to implement

the regulation, and they believed the distinctions in the APY produced

by the complex formula proposed by Approach A did not warrant the

substantial costs of implementing changes to the regulation--perhaps as

much as 50% of the initial costs to implement the regulation.

The Board concurs with the commenters that voiced concern about the

complexity of the proposed formula. These commenters noted that the

formula was complex for both consumers and institutions. Many

commenters stated that although an internal rate of return formula is a

standard mathematical tool in the financial markets, its introduction

in APY calculations would eliminate, as a practical matter, the use of

many handheld calculators for preparing disclosures or quoting APYs to

consumers. Commenters also noted due to the complexity of the APY

calculation there would be an increased risk of error and potential

civil liability in making this calculation for a wide variety of

accounts.

The Board also notes the views of commenters that believed that in

adopting Approach A, the Board would merely be trading one set of

assumptions for another set of assumptions. Many commenters concurred

with the Board that the current APY does not always reflect the value

of periodic interest distributions, for example. But they also believed

that the proposed APY also would not be factually accurate in all

circumstances. For example, commenters remarked that the proposed APY

would fail to reflect the fact that interest payments cannot always be

immediately reinvested at the same rate as the account from which the

interest was paid. They also believed it would be inappropriate to

assume such a reinvestment rate for small monthly interest checks, for

example, since rates typically rise based on the length of maturity and

amount of principal. They noted that elderly consumers who hold multi-

year CDs and who rely on periodic interest payments for living expenses

would be particularly affected by the assumption.

Commenters noted that returns on deposit accounts traditionally

have been based on the rate of interest paid and any compounding

frequency. Higher yields historically have been equated with higher

dollar interest payments--not more frequent interest payments--and

commenters believed that consumers expect an APY to reflect those

factors. Many commenters believed that the underlying premise of

Approach A--the time value of money--is inappropriate for deposit

account disclosures. Many believed an assumption based on potential

earnings outside the account relationship was misleading for the APY

calculation. They believed the purposes of Truth in Savings are not

best served by an APY disclosure based on the timing of interest

payments that is higher for consumers who receive less interest

overall.

Due to concerns about costs and questions about the benefits

provided, the Board believes this approach would not be the best

solution.

Approach B: Noncompounding Multi-Year CDs

The Board also is not adopting Approach B, based on the combination

of the limited scope of the problem Approach B seeks to address, the

creation of new anomalies, and the cost to the industry of reviewing

and implementing new calculation and disclosure requirements.

On the one hand, the Board believes Approach B is a simple, direct

approach to correct one anomaly produced by the current APY formula.

The Board also recognizes that the disclosure of an APY that is lower

than the interest rate on a noncompounding multi-year CD that pays

interest at least annually may be confusing to some consumers.3

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\3\The Board notes, however, that even if Approach B were

adopted, institutions would still disclose an APY lower than the

interest rate, such as for a multi-year CD that does not compound

and pays interest only at maturity.

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Overall, however, the Board is more persuaded by commenters that

voiced concern about the accuracy of the APY disclosed under Approach

B. For example, commenters echoed concerns expressed about the proposed

formula in Approach A. They remarked that the APY permitted under

Approach B assumed the interest payments received during the term would

be reinvested at the same rate as the account from which the interest

was paid. Others believed it would be anomalous to disclose the same

APY is disclosed for two multi-year accounts, one compounding annually

and the other not compounding at all.

The Board also notes the commenters' concerns about the cost to the

industry of reviewing and implementing new calculation and disclosure

requirements. They noted the costs of implementing Approach B would be

less significant, compared to Approach A. Although the change would

affect a single class of accounts, commenters reported that some

computer programming changes would be required and additional

disclosures would be appropriate. Commenters stated that since

consumers would see the same APY for compounding and noncompounding

CDs, a statement might be necessary in advertisements and account

disclosures to help consumers understand the terms of the account. (For

example, assume two institutions offer a two-year CD with a 6.00%

interest rate. One compounds annually, the other offers annual interest

payments. Both could advertise a 6.00% APY, even though a consumer

depositing $1,000 receives $120 if interest checks are paid and $123.60

if interest is compounded.) Finally, the Board notes some commenters

remarked that institutions could easily remedy the current anomaly with

a simple change to their product. They noted institutions could

advertise and disclose an APY equal to the contract interest rate under

the current formula by offering CDs that have annual compounding,

regardless of any payment options.

Due to the limited problem Approach B seeks to address, the limited

resolution of anomalies produced by the current APY formula, and the

costs associated with adopting the approach, the Board has determined

not to adopt Approach B.

(3) Regulatory flexibility analysis and Paperwork Reduction Act

The Board solicited comment on the potential cost of implementing

the proposed APY formula, such as the proportion of existing accounts

would require the new formula for computing APYs, the changes

institutions would have to make to implement the new formula, the cost

to make these changes, and the likelihood of changes in the number of

different account terms and types of accounts offered would result if

the new formula were adopted.

In accordance with section 3507 of the Paperwork Reduction Act of

1980 (44 U.S.C. 35; 5 CFR 1320.13), the proposed revisions were

reviewed by the Board under the authority delegated to the Board by the

Office of Management and Budget after consideration of comments

received during the public comment period. The Board's Office of the

Secretary has prepared an economic impact statement on the proposed

revisions to Regulation DD, a copy of which may be obtained from

Publications Services, Board of Governors of the Federal Reserve

System, Washington, DC 20551, at (202) 452-3245.

Board of Governors of the Federal Reserve System, May 4, 1994.

William W. Wiles,

Secretary of the Board.

[FR Doc. 94-11153 Filed 5-10-94; 8:45 am]

BILLING CODE 6210-01-P