WASHINGTON - After more than a year of debate, the Federal Reserve Board voted 4-3 Wednesday to change the way banks calculate annual percentage yields under Truth-in-Savings.
The new calculation will reflect both the effect of compounding as well as the value of receiving interest during the term of an account.
The new rule takes effect immediately, although regulators will not enforce it until September, the Fed said.
Since June 1993, when Regulation DD kicked in and banks had to start disclosing annual percentage yields, the calculation has produced separate rate and yield numbers.
Fed Vice Chairman Alan S. Blinder said the old formula is simply wrong.
"Two plus two is four no matter how many commenters say it is 3.8," Mr. Blinder said.
He said the new calculation will best accomplish what Truth-in-Savings is designed for - helping consumers comparison-shop among banks.
The new rule was one of several options the Fed has been considering since December 1993. The alternative selected is the least popular: 98% of the 450 commenters on this version opposed it.
Although Mr. Blinder claimed the change will not impose higher costs on banks, Diane Casey, executive director of the Independent Bankers Association of America, said the rule will force banks to spend money on training, computer software, and printing.
"It's an ivory tower approach," she said. "In the real world, it's not going to make a difference" to customers.
It was clear at the Fed meeting that writing this regulation has been a long, confusing exercise.
To laughter, Mr. Blinder said the issue reminded him of an Albert Einstein quote: "Everything should be made as simple as possible, but not more so."
Fed Chairman Alan Greenspan, who voted no, said he was uncomfortable with the issue.
Mr. Greenspan questioned several times why community groups have not been complaining to the Fed if the current annual percentage yield calculation does not work.
"This violates my view of rational expectations," he said.
Mr. Greenspan also questioned the usefulness of Truth-in-Savings in general. "To what extent do we wish to enforce a correct comparison shopping system when no one seems to want it?" he asked.
The Fed's attempt to change the way annual percentage yields are calculated began in December 1993, when the central bank proposed the first alternative.
Bankers had complained that because the yield could be different from the interest rate, it confused customers.
But negative comments on the December 1993 proposal prompted the Fed to withdraw it in May and simultaneously issue another proposal.
Bankers complained about the second version as well, even asking for the December option to be brought back. The Fed re-proposed it in July.
In adopting this approach, the Fed board rejected its staff's recommendation, which called for a much narrower approach in equating yields and interest rates. That plan would have affected only noncompounding CDs with maturities greater than one year that mandate interest payments at least annually.
That plan, termed the "surgical fix" option, also would have changed the definition of annual percentage yield to factor in the timing of payments.