Why are corporations not allowed to earn interest on their checking accounts?

Answer 1

Federal Reserve Regulation Q is the reason why corporations are not allowed to earn "hard interest" on their checking accounts (or demand deposit accounts). Reg Q came to be primarily as a result of the Glass-Steagall act of 1933, primarily as a response to many bank failures that had taken place. At that time, one of the reasons that was given for bank failures was high expenses for paying interest, and intense competition between banks to entice deposits by paying high interest on deposits. The nature of demand deposit accounts is that the money can be withdrawn at any time. At that time, many corporations kept large amounts of cash in banks, which in turn loaned those deposits out. If a large corporation came into a bank and withdrew all of their cash from a large balance demand account, the bank would almost certainly fail.

In an attempt to reduce this risk, and end intense interest rate competition among banks, Req Q set a cap on the interest rate that could be paid on deposit accounts. The capped rate on corporate demand deposit accounts has been set at zero since that time.

This has had the basic effect of enticing corporations to move their excess funds out of the banking system, and into vehicles that provide a real rate of return. It has also led to cash management services offered by banks that help a corporation keep exactly the right amount of money in their operating account, while moving all excess funds into interest bearing accounts on a daily basis. Banks have also come up with other creative ways of getting around the interest restrictions on corporate demand accounts through the use of a "soft credit" known as the earnings credit rate. Earnings credit on a corporate demand account looks, smells and acts exactly like interest paid on an account with one significant exception. The interest earned through earnings credit can only be used to pay for the services of the bank, and once those services have been fully paid for, any excess in earnings is lost.

There are complex calculations to help a company determine whether it makes the most sense to avoid bank service charges by maintaining high balances and offsetting their charges with earnings credit, or minimizing their balances, and paying their bank fees as normal expenses. In today's world, it almost always makes the most sense to continue to minimize balances and pay for the bank fees as expenses, but that is determined by the various rates being applied. With a variety of challenges facing the Federal Reserve system, and what some refer to as a liquidity crisis within the system, there has been an effort in recent years to repeal Reg Q. For more than four years in a row, the House of Representatives has passed a bill calling for the repeal of Reg Q over a three year period. However, every year that it has passed the House, it has stalled in the Senate banking committee with no action taken. In my opinion, Regulation Q was a kneejerk reaction to the swirling world of the Depression, and over time has had almost the opposite effect of what was intended.