For the last five years, Neal Mahoney has been pushing an unpopular idea on his fellow community bankers-paying interest on small-business deposits.
"I still don't think bankers around the country have been throwing their arms around this," said Mr. Mahoney, president and chief executive of $330 million-asset Woronoco Savings Bank in Westfield, Mass.
But Mr. Mahoney said community banks need to offer interest on small- business deposits as low as $2,500 to keep their customers from defecting to larger banks as they grow.
By law, banks cannot pay interest on small-business demand deposits, but they can pay interest on deposits in money market accounts.
Mr. Mahoney has been urging his legislators to change the law. Rep. Jack Metcalf, R-Wash., has sponsored a bill to allow banks to pay interest on deposits in business checking accounts, and the Federal Reserve has endorsed the approach.
Larger banks get around the restriction by offering sweep accounts, which automatically transfer balances above a certain amount into proprietary money market or mutual funds.
"If they are doing it anyway, why not eliminate the law?" Mr. Mahoney said.
Robert Verdonck, president and chief executive office of $431 million- asset East Boston Savings Bank, said he doesn't want to pay interest on all deposits but would like to offer sweep accounts.
Mr. Verdonck said competition from Fidelity Investments and Merrill Lynch, which can pay interest on small business deposits, lead him to support the idea.
"They've been effective at drawing deposits away from banks," he said.
Nearly two thirds of the banks surveyed by the Consumer Bankers Association offer sweep accounts. But Mr. Mahoney said it is harder for small banks to offer sweep accounts because they don't have proprietary mutual funds, and transferring money is labor intensive.
Joseph D. LoBello, president and chief executive of Peoples Bank of Holyoke, Mass., said many community bankers who balked at the idea of paying interest on business deposits a few years ago now want to offer sweep accounts.
"Community bankers recognize that we are all at risk," he said. "We have to pay interest on excess funds that traditionally have been parked in non- interest-bearing accounts."