Truth in Savings; Proposed Regulatory Amendment

FEDERAL RESERVE SYSTEM

12 CFR Part 230

[Regulation DD; Docket No. R-0836]

Truth in Savings; Proposed Regulatory Amendment

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Proposed rule.

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SUMMARY: The Board is publishing for comment proposed amendments to

Regulation DD (Truth in Savings) which clarify that once interest is

credited to an account, it becomes part of the principal. By defining

terms such as ``crediting,'' and ``compounding,'' the amendments will

provide certainty to institutions, better fulfill the purposes of the

act, and eliminate anomalies that currently occur in the APY

calculation. The amendments provide that for institutions that pay

interest (that is, credit interest) to the consumer by check or

transfer or permit interest to remain in the account, an institution

must pay interest on funds that remain in the account at the same

frequency as the institution credits interest by check or transfer.

Accounts that credit interest solely by posting to the account would

not be required to send out interest checks or to transfer the interest

to other accounts. Similarly, institutions offering accounts that

``credit'' interest solely by paying it out to the consumer by check or

transfer would not be required to permit credited interest to remain in

the account for compounding.

DATES: Comments must be received on or before July 5, 1994.

ADDRESSES: Comments should refer to Docket No. R-0836, and may be

mailed to William W. Wiles, Secretary, Board of Governors of the

Federal Reserve System, 20th Street and Constitution Avenue NW.,

Washington, DC 20551. Comments also may be delivered to room B-2222 of

the Eccles Building between 8:45 a.m. and 5:15 p.m. weekdays, or to the

guard station in the Eccles Building courtyard on 20th Street NW

(between Constitution Avenue and C Street) at any time. Comments may be

inspected in Room MP-500 of the Martin Building between 9 a.m. and 5

p.m. weekdays, except as provided in 12 CFR 261.8 of the Board's rules

regarding the availability of information.

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 annual percentage yield (APY) on

interest-bearing accounts. The act is implemented by the Board's

Regulation DD (12 CFR part 230), which became effective June 21, 1993

(See 57 FR 43337 and 58 FR 15077).

Because the current formula for calculating the APY assumes that

interest remains on deposit until maturity, the resulting APY may--but

does not always--reflect the time value of money. On December 6, 1993,

the Board published a proposal that would have factored into the APY

calculation the specific time intervals for interest paid on the

account--that is, the time value of money (58 FR 64190). It called for

adding an additional APY formula. Based on the comments received and

upon further analysis, the Board has withdrawn the proposed amendments.

(See Docket R-0812 elsewhere in today's Federal Register.) Compounding

and crediting issues.

In the context of deliberations about the APY proposal, the Board

has considered two related issues regarding depository institutions'

compounding and crediting practices. This relationship between

crediting and compounding has not previously been addressed in the

regulation or in supplementary information. (The resolution of these

issues, as discussed below, could provide an alternative basis for

eliminating the anomaly produced by the current formula while requiring

few changes to the current APY formula.)1

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\1\If an institution offers a multi-year noncompounding CD, the

APY produced by the current formula is less than the interest rate,

even if the institution pays out interest annually or more often.

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The act requires institutions to pay interest on the full amount of

the principal in the account each day, and provides that this

requirement shall not be construed as prohibiting or requiring the use

of any particular method of compounding or crediting interest.

Regulation DD states that the requirement to pay interest on the full

amount of principal does not require institutions to compound or credit

interest at any particular frequency. Neither the act nor the

regulation defines ``compounding,'' ``crediting,'' or ``principal.''

One issue that has arisen is whether interest can be posted to a

consumer's account and not be treated as part of the principal. Another

is whether institutions that offer to credit interest to the consumer

by check or transfer and permit interest to remain in the account must

credit and compound interest on the same or a more frequent basis for

those consumers that leave interest in the account. For example, if an

institution offers a two-year certificate of deposit (CD) and permits

consumers to receive accrued interest in monthly interest checks, does

the institution that also permits interest to remain in the account

have to credit and compound interest in the account on the same or more

frequent basis (monthly or more often).

The Board recognizes that institutions may have read the act and

regulation as permitting practices which compound and credit at

different intervals. The Board is proposing to amend the regulation to

clarify that interest cannot be credited to a consumer's account

without becoming part of the principal. For example, assume a consumer

earns $5 in interest on a $1,000 balance for the month of January. If

an institution chooses to credit interest to the account monthly, then

the institution must accrue interest on that sum. For example, if $5 is

credited in January to an account with a balance of $1,000, the

institution must accrue interest on $1,005 for the month of February.

Simply put, if consumers are given access to earned interest in an

account, the Board believes the act requires that consumers earn

interest on those funds at that time.

The Board also proposes an amendment clarifying that although

institutions may choose any compounding or crediting frequency for an

account, institutions that provide for crediting interest either by

check (or transfer of accrued interest to another account) or by

posting interest to the account must do so on the same periodic basis.

That is, if interest can be ``credited'' by check or transfer, an

institution must credit interest to all such accounts at least as often

a frequency. For example, an institution offering a one-year CD with

the option to receive monthly or quarterly interest checks would have

to credit interest to the account for compounding on at least a monthly

frequency.

Of course, an institution need not permit consumers to receive

interest payments by check or transfer. Similarly, the Board believes

that if an institution requires consumers to receive interest solely by

check (or transfer to another account), the institution need not also

permit consumers to leave interest in the account for compounding.

The Board notes that this proposed interpretation could require a

change in the compounding and crediting practices of some depository

institutions, since institutions that do not currently compound on the

same basis as they offer interest payments would have to change

compounding frequencies or reduce payment options. The impact of the

proposed amendments may be greater for those institutions offering

consumers many options in crediting frequencies. For example, an

institution permitting quarterly interest payments must also credit and

compound at least quarterly for those consumers who choose to leave

interest in the account. If an institution allows consumers to receive

monthly interest checks (and can leave interest in the account), the

institution could not offer this option without offering monthly

crediting and compounding to other holders of the same account as well.

The Board requests comment on these matters.

The Board also solicits comments on whether consumers who use APYs

to comparison shop may be confused by an APY that reflects monthly

compounding but pays less interest than if interest had compounded in

the account. For example, assume two institutions offer a one-year CD

with a 6.00% interest rate. One mandates monthly interest checks, the

other permits monthly interest checks or monthly compounding. Both

could advertise a 6.17% APY, even though a consumer depositing $1,000

receives $60 if interest checks are paid and $61.70 if money is left in

the account.

(2) Proposed Regulatory Revisions: Section-by-Section Analysis

A section-by-section description of proposed amendments follows.

Sec. 230.2 Definitions.

Paragraph (c)--Annual Percentage Yield

The act and regulation define the APY as the total amount of

interest that would be received based on the interest rate and the

frequency of compounding for a 365-day year. The proposed amendment

broadens the definition to treat crediting to the consumer's account--

which includes the distribution of interest through interest checks or

transfer--as the equivalent of compounding. For example, if an

institution pays a 6.00% interest rate on an account, the same APY

would result whether an institution compounds monthly or solely sends

out monthly interest payments and does not permit interest to remain in

the account.

The Board solicits comments on whether an exception should be made

to the definition of APY, and whether the purpose of the regulation--

enabling consumers to make informed decisions about deposit accounts--

is better met if the APY captures the time value of interest received

as an interest payment during the term of the account, as well as by

compounding.

Paragraph (h)--Compounding

The act and regulation require institutions to disclose compounding

policies for interest-bearing accounts. The Board proposes to define

the term ``compounding'' as the frequency that earned interest is added

to the principal in the consumer's account, on which interest then

accrues. To illustrate, a CD offering monthly compounding adds interest

to principal each month, and interest then accrues on the new month's

principal--including the prior month's accrued interest.

Paragraph (j)--Crediting

The act and regulation also require institutions to disclose

crediting policies for interest-bearing accounts. The Board proposes to

define the term ``crediting'' to include the frequency that earned

interest is paid to the account, or provided to the consumer by check

or transfer to another account. Thus, for example, an institution that

sends a consumer a monthly check of accrued interest would be crediting

interest monthly, even if interest were not permitted to remain in the

account to earn additional interest.

Sec. 230.4 Account Disclosures.

Paragraph (b)(6)(iii)--Withdrawal of Interest Prior to Maturity

The regulation requires a disclosure for institutions offering time

accounts that compound interest and permit a consumer to withdraw

accrued interest during the account term. The disclosure states that

the APY assumes interest remains on deposit until maturity and that a

withdrawal will reduce earnings. The Board requests comment on whether

the disclosure would continue to be helpful to consumers in the current

form if the proposed amendments are adopted.

Sec. 230.7 Payment of Interest.

Paragraph (b)--Compounding and Crediting Policies

The act requires institutions to pay interest on the full amount of

the principal in the account each day, and provides that this

requirement shall not be construed as prohibiting or requiring the use

of any particular method of compounding or crediting interest.

Regulation DD states that the requirement to pay interest on the full

amount of principal does not require institutions to compound or credit

interest at any particular frequency.

As discussed above, the Board believes institutions may choose any

compounding or crediting frequency. However, once interest is credited

to an account it becomes part of the principal, and if interest remains

in the account, interest must be paid on those funds. The Board

believes institutions may choose to offer accounts that credit interest

solely by posting interest to the account, or by sending interest

checks or transferring the interest to another account. But the Board

also believes institutions offering accounts that provide consumers

with the option to have interest credited by check (or transfer to

another account) or by posting interest to the account provide at least

as frequent a crediting frequency to all holders of the same account.

That is, institutions must compound interest on funds remaining in the

account at a frequency no less often than interest is offered to be

credited--by check or transfer--to other consumers holding such

accounts. For example, institutions may offer a one-year CD with

monthly compounding and the option to receive monthly or quarterly

interest checks, but they may not combine quarterly compounding with

the option to receive monthly interest checks. The Board requests

comment on the proposal.

Appendix A to Part 230--Annual Percentage Yield Calculation

Part I. Annual Percentage Yield for Account Disclosures and Advertising

Purposes

A. General Rules

The proposed amendments to Appendix A only affect institutions that

credit interest solely by check or transfer to another account (and

that do not permit the consumer to leave interest in the account). The

Board proposes two amendments to Appendix A to address the calculation

of the APY for these accounts. First, the Board proposes to delete

footnote 3 as unnecessary. Second, the definition of ``Interest'' in

the APY formula would be amended to provide that for such accounts,

institutions would factor in the timing of interest payments as if

interest were being compounded. For example, if an institution offers a

two-year CD with a 6.00% interest rate and credits interest semi-

annually to the consumer by check or transfer to another account, the

``Interest'' figure used in the APY formula would be $125.51 on a

$1,000 deposit. This would be the dollar amount of interest earned for

a two-year CD with a 6.00% interest rate that compounds semi-annually.

The APY would be 6.09%.

Finally, the Board also provides guidance on two assumptions for

calculating the APY that provide greater flexibility and ease

compliance with the APY formula. First, institutions could calculate

the APY by assuming an initial deposit amount of $1,000. Second, if

interest is paid out monthly, quarterly, or semi-annually, institutions

could base the number of days either on the actual number of days for

those intervals or on an assumed number of days (30 days for monthly

distributions, 91 days for quarterly distributions, and 182 days for

semiannual distributions).

Appendix B--Model Clauses and Sample Forms

The Board solicits comments on model clauses or additional sample

forms that may be appropriate if the amendments are adopted.

(4) Proposed Additional Guidance

The proposed regulatory amendments associated with a new APY

formula raise other interpretive issues. The Board solicits comments on

the issues addressed below:

1. Comparing accounts that disclose the same APY but earn different

dollar amounts of interest. Under the proposal, consumers may receive

the same APY disclosure but different dollar amounts of interest.2

The Board solicits comment on whether consumers who are comparison

shopping would be better served if the specific manner in which

interest is credited (such as, ``An annual percentage yield of 6.17%

with monthly interest checks'') should be stated along with the APY.

(See Secs. 230.3(e), 4(a)(ii), 4(b)(1)(i), 5(b), 8(b).)

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\2\For example, assume a one-year CD that pays an interest rate

of 6.00%. Consumers would receive an APY of 6.17% if the institution

requires monthly interest payments. Or, if the institution permits

interest to be withdrawn monthly instead, the proposed amendments

would also require institutions to permit interest to remain in the

account for monthly compounding. Consumers holding this account

would also receive an APY of 6.17% whether the consumer chooses to

take monthly interest checks or to have interest remain in the

account. However, based on a $1,000 deposit consumers who receive

interest checks will earn $60.00, while those who compound interest

will earn $61.70.

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2. Compounding and crediting frequencies. The regulation requires

institutions to disclose the frequency with which interest is

compounded and credited. This standard would require institutions also

to specify the crediting frequency for interest payments sent directly

to the consumer or to another account, whether by check or other means,

as well as when interest is credited to the account. The Board solicits

comment on the proposed disclosure and on whether stating the frequency

of crediting by interest payments or transfers to other accounts is

likely to help consumers compare and understand differences in account

terms. (See Sec. 230.4(b)(2).)

(5) Form of Comment Letters

Comment letters should refer to Docket No. R-0836, and, when

possible, should use a standard typeface with a type size of 10 or 12

characters per inch. This will enable the Board to convert the text

into machine-readable form through electronic scanning, and will

facilitate automated retrieval of comments for review. Also, if

accompanied by an original document in paper form, comments may be

submitted on 3 1/2 inch or 5 1/4 inch computer diskettes in any IBM-

compatible DOS-based format.

(6) Regulatory Flexibility Analysis and Paperwork Reduction Act

The Board's Office of the Secretary has prepared an economic impact

statement on the proposed revisions to Regulation DD. The analysis

expresses concern about the desirability of amending the regulation

regarding the linkage of compounding and crediting frequencies at this

time. A copy of the analysis may be obtained from Publications

Services, Board of Governors of the Federal Reserve System, Washington,

DC 20551, at (202) 452-3245.

The Board solicits information regarding the likely costs for

complying with the proposed changes to the regulation. In particular,

the Board solicits comments on the following:

What proportion of existing accounts would be affected by

the proposed new rule requiring institutions to offer compounding on

the same frequency as they permit interest payouts?

What changes would institutions have to make to implement

the proposed new compounding and crediting rule, and what would it cost

institutions to make these changes?

What changes in the number of different account terms and

types of accounts offered would result if the proposal were adopted?

For example, would institutions reduce the number of products offered?

What effect would the amendments have on ``private banking''

relationships? Would institutions change from compounding to

distributing the interest paid on accounts without compounding?

In accordance with section 3507 of the Paperwork Reduction Act of

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

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.

List of Subjects in 12 CFR Part 230

Advertising, Banks, Banking, Consumer protection, Deposit accounts,

Interest, Interest rates, Truth in savings.

Certain conventions have been used to highlight the proposed

revisions to the regulation. New language is shown inside bold-faced

arrows, while language that would be deleted is set off with bold-faced

brackets.

For the reasons set forth in the preamble, the Board proposes to

amend 12 CFR part 230 as follows:

PART 230--TRUTH IN SAVINGS (REGULATION DD)

1. The authority citation for part 230 would continue to read as

follows:

Authority: 12 U.S.C. 4301 et seq.

2. Part 230.2 would be amended by revising paragraph (c), by

redesignating paragraph (h) and paragraphs (i) through (v) as paragraph

(i) and paragraphs (k) through (w), respectively, and by adding new

paragraphs (h) and (j) to read as follows:

Sec. 230.2 Definitions.

* * * * *

(c) Annual percentage yield means a percentage rate reflecting the

total amount of interest paid on an account, based on the interest rate

and the frequency of crediting or compounding, for a

365-day period and calculated according to the rules in Appendix A of

this part.

* * * * *

(h) Compounding means the frequency that earned interest

is added to the principal in the account on which interest then

accrues.

* * * * *

(j) Crediting means the frequency that earned interest is

paid to the account, or provided to the consumer by check or transfer

to another account.

* * * * *

3. Section 230.7 would be amended by redesignating paragraph (b) as

paragraph (b)(1) and by adding a new paragraph (b)(2) to read as

follows:

Sec. 230.7 Payment of interest.

* * * * *

(b) * * *

(2) Equivalent compounding and crediting frequencies.

Institutions offering accounts that permit consumers to receive

interest by check or transfer to another account and that permit

consumers to leave interest in the account, must compound interest on

funds left in the account at a frequency no less often than interest is

offered to be credited to any consumer holding such an

account.

* * * * *

4. Appendix A of part 230 would be amended by revising the first

sentence in the introductory paragraph, the introductory text to Part

I, and amending paragraph A, and by removing footnote 3 in Part I of

Appendix A to read as follows:

Appendix A to Part 230--Annual Percentage Yield Calculation

The annual percentage yield measures the total amount of interest

[paid] earned on an account based on the interest

rate, and the frequency of compounding[,] or

crediting.1 * * *

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\1\ The annual percentage yield reflects only interest and does

not include the value of any bonus (or other consideration worth $10

or less) that may be provided to the consumer to open, maintain,

increase or renew an account. Interest or other earnings are not to

be included in the annual percentage yield if such amounts are

determined by circumstances that may or may not occur in the future.

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Part I. Annual Percentage Yield for Account Disclosures and Advertising

Purposes

In general, the annual percentage yield for account disclosures

under Secs. 230.4 and 230.5 of this part and for advertising under

Sec. 230.8 of this part is an annualized rate that reflects the

relationship between the amount of interest that would be earned by the

consumer for the term of the account (and taking into account

the frequency of crediting) and the amount of principal used

to calculate that interest. Special rules apply to accounts with tiered

and stepped interest rates.

A. General Rules

* * * In determining the total interest figure to be used in the

formula, institutions shall assume that all principal and interest

remain on deposit for the entire term and that no other transactions

(deposits or withdrawals) occur during the term.[3] * * *

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\3\[This assumption shall not be used if an institution

requires, as a condition of the account, that consumers withdraw

interest during the term. In such a case, the interest (and annual

percentage yield calculation) shall reflect that requirement.]

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The annual percentage yield is calculated by use of the following

general formula (``APY'' is used for convenience in the formulas):

APY=100 [(1+(Interest/Principal))(365/Days in term)-1]

``Principal'' is the amount of funds assumed to have been deposited

at the beginning of the account.

``Interest'' is the total dollar amount of interest earned on the

Principal for the term of the account in which credited

interest remains in the account. If interest is required to be credited

solely by check or transfer, the total dollar amount of interest earned

on the Principal for the term of the account is the amount of interest

that would result if it were compounded at the same frequency interest

is credited.

``Days in term'' is the actual number of days in the term of the

account.

* * * * *

Examples:

* * * * *

(3) If an institution offers a $1,000 two-year certificate

of deposit that credits interest semi-annually solely by check or

transfer, and there is no compounding at a 6.00% interest rate, using

the general formula above, the annual percentage yield is 6.09%:

APY=100 [(1+(125.51/1,000))(365/730)-1]

APY=6.09%

* * * * *

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

William W. Wiles,

Secretary of the Board.

[FR Doc. 94-11154 Filed 5-10-94; 8:45 am]

BILLING CODE 6210-01-P