Rethinking Reclassification of Deposits

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While the credit union market has grown in the past few years, in an effort to continue growing its membership base, credit unions must be proactive about seeking ways to increase profitability. By increasing profits, credit unions are able to use the excess cash for investment or loan opportunities.

As transactional deposits increase, credit unions must learn how to best manage these accounts, particularly under an increasingly regulated environment and increasing interest rates. To improve revenue streams, many credit unions have turned to deposit reclassification, a simple procedure that enables credit unions to restructure transaction (share draft or checking) accounts and convert non-interest earning reserve requirements into an interest earning asset. The process enables financial institutions to dramatically increase earning assets by $2 to $10M per day. To understand the full benefits of deposit reclassification, the way it works should be clear, as institutions have the ability to accrue these savings year after year.

Deposit reclassification represents a change in the method by which transaction accounts (both interest and non-interest) are reported to the Federal Reserve for Regulation D or Reserve Requirement of Depository Institutions. Regulation D requires a 10% reserve requirement on all transaction accounts. This requirement must be maintained as a non-interest earning asset, limiting what can be deemed a savings account by a six transaction per month limit.

Deposit reclassification segments both interest and non-interest checking accounts into separate savings and checking subaccounts using an algorithm that recognizes the volatility of balances. An average of 80% of a credit union's transactional accounts can be reported as savings deposits and as a result, credit unions experience a significantly low reserve requirement. Other than an initial disclosure note to members, all of the calculations and transfers are invisible to the member.

The amount of money placed in the savings subaccount is unique to each account. A threshold percentage is determined by checking the type of account and the balance range to identify the relative volatility of the account. A high balance, low volatility account would use a high threshold percentage, whereas a low balance, high volatility account would use a low threshold percentage. Once the threshold is established, accounts are evaluated daily to ensure proper balances. Funds are automatically transferred between savings and checking subaccounts, if need be, an action that is invisible to members. If the activities within the account during a calendar month force a sixth transfer from the savings subaccount to the checking subaccount, the entire balance is transferred to the checking subaccount until a new calendar month begins. This allows the entire process to remain in compliance with Regulation D.

The process can be expanded to include savings and money market accounts linked to a transactional account. Regulation D states that all savings and money market accounts linked to transaction accounts with automatic transfer capabilities are to be reported as transaction accounts and subject to the 10% reserve requirement. So, for credit unions, deposit reclassification adds flexibility to money market and savings accounts and alleviates transactional limitations without the corresponding reserve penalty.

Deposit reclassification maximizes the balance of the savings subaccount each day.

This process can best be described by showing the impact on a sample checking account. This chart tracks a checking account with a starting balance of $10,000 through each day of the month. Daily, deposit reclassification compares the ending balance of the saving subaccount and the status of the transfer counter. If the checking account balance is lower than the balance of the savings subaccount from the previous day, a transfer is made back to the checking subaccount, raising the transfer counter by one. If the reverse holds true, the checking account balance is multiplied by the threshold percent to determine if a transfer from the checking subaccount to the savings subaccount is needed. No increment is made to the transfer counter, since only debit transfers are counted. This process continues until the transfer counter reaches six, at which point, the entire balance resides in the checking subaccount through the end of the month when the transfer counters are reset.

Credit unions can easily manage deposit reclassification with the help of a fairly basic database software package. Database deposit reclassification can be implemented under a credit union's existing Microsoft ACCESS license or SQL; a mainframe setup would be a financial drain on any credit union. Additionally, the database approach enables credit unions to have more control over individual accounts. It provides detailed reports useful for evaluations on FR2900 and call report inquiries. Database setups enable management and internal accounting to control the algorithm system to ensure the process maximizes the amounts placed in savings subaccounts.

The Federal Reserve must be notified of all deposit reclassification implementations. A detailed letter outlining how the program will operate along with a copy of the disclosure note for members will suffice. The disclosure note is a simple process to notify members that checking and savings subaccounts will be created and maintained, and that transfers may occur between these subaccounts. Members may be informed that this will have no negative affect on their accounts. A statement stuffer is an acceptable means to distribute this letter. After the initial letter, a modification to the Terms and Conditions sheet of new accounts is all that is necessary.

A simple installation can be completed and funds converted within 45 days, enhancing efficiency and producing immediate benefits. The process is an opportunity for credit unions to improve net interest margins and increase profits year after year. Any financial institution would be remiss not to consider it.

Douglas Ceto is senior vice president for Ceto and Associates, Suwanne, Ga.. Mr. Ceto can be reached at 678-297-1151.

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