Critical first step involves reassuring Federal Reserve that the arrangement is fully disclosed and on the up and up.
ATLANTA - On its surface, the concept of converting non-interest earning assets to those that actually earn interest and reduce the reserve requirements at the Federal Reserve Banks and be in compliance, sounds almost too good to be true. But a number of credit unions are doing just that through a system that analyzes an institution's transaction accounts to convert those accounts to savings deposits. One firm, Atlanta-based Ceto and Associates, Inc. has implemented its Deposit Reclassification service at more than 30 credit unions. To understand how it works, the Fed's Regulation D or Reserve Requirement of Depository Institutions should be clear first. The regulation puts a six-transaction per month limit on any combination of withdrawals or transfers involving automatic payments (ACH); e-banking; telephone banking; automatic transfers to checking from savings to cover overdrafts; and requests by fax to withdrawal or transfer money from savings. The regulation is essentially in place to keep a lid on unlimited transactions on a savings account to prevent it from becoming a transaction account. If unlimited transactions are made, a credit union would have to keep reserves for those accounts. The money that is kept in a savings account is treated as a reserve. Here's how deposit reclassification works: interest and non-interest checking accounts are segmented into separate sub-accounts unique to each account. The savings sub-account of the combined account balance is not subject to the 10% reserve requirement. The net impact is a credit union's reserve requirements fall to insignificant levels. Other than an initial, non-adverse notice to the customer, this process of transferring funds to the savings sub-account is invisible to your customer. The checking and savings sub-accounts are evaluated daily. Funds are automatically transferred from the savings sub-account to the checking sub-account if required to cover activity in the account. Concurrent with the sixth such transfer during a calendar month, the entire balance is transferred to the checking sub-account to remain in compliance with restrictions on savings accounts imposed by Regulation D. Since 1994, Ceto has implemented the Deposit Reclassification process for more than 400 banks, thrifts and credit unions in all 12 Federal Reserve Bank districts, according to the company's Web site. Its clients have collectively increased their annual earning assets by $4.5 billion, the company claimed. "Implementation of deposit reclassification is much more than a data processing change because it involves a contractual change in the way a customer's account is processed, using a unique interpretation of Reg D," said Joe Moss, director at Ceto and Associates. The Fed allows the use of deposit reclassification only if it is properly disclosed to the customer, which means proper disclosure is critical to the process, Moss said. "In the Fed's opinion, the savings sub-account must be interpreted as a legally separate savings account to qualify as a savings account for purposes of Reg D," Moss said. "Since this process is invisible to the member, the disclosure is the process by which the savings sub-account becomes legally separate." Moss said there has been considerable debate about this issue among the "Reg D purists." "Since the customer is unaffected and no adverse change is being made to the customer's account, the need for disclosure has been questioned, he said. "However, the Fed has been quite adamant on this issue. This process is a contractual change in the way the customer's account is processed. To effect this change to the contract, the customer must be notified. Continued use of the account after disclosure constitutes acceptance." For $1.6 billion Eastern Financial Florida Credit Union, which has been using Ceto's deposit reclassification process for three years, the move in that direction was prompted by a surge in checking account growth, said Kendrick Smith, CFO at EFFCU. We had been growing checking accounts expeditiously for several years and was running into reserve requirements," Smith said. "But we weren't opening branches at the same pace as checking accounts and didn't have any vault cash." The credit union started looking around in the marketplace for a solution that would eliminate the reserve requirement while still being in compliance with Regulation D and have the ability to invest those funds. "We worked to make sure that we met all the Reg D requirements," Smith said. "We had money market accounts that were linked to checking accounts so we had to alter those accounts." Moss said they are aware of some financial institutions that have chosen not to disclose deposit reclassification to their customers but after their regulatory compliance examination, some have had to suspend it and restate reserve requirements with penalties as a result of not disclosing. Financial institutions have also tried to disclose to the customer without truly informing the customer of the entire process. Disclosures referring to deposit reclassification as "an internal bookkeeping process only" or "an internal reclassification of deposit accounts" have also been denied by the Fed. "The customer (or member) must be told that checking and savings sub-accounts will be created and maintained and that transfers may occur between these sub-accounts," Moss cautioned. "However, the customer may be told that it will not negatively affect their account." Still, many financial institutions have been concerned that the disclosure may create substantial dissension among their customers, Moss offered. "The empirical evidence from actual disclosures suggests that negative customer reaction has been minimal, probably because they can be assured that the change is a non-adverse change to their account," Moss said. -