In 2002, Appalachian Bancshares Inc. in Ellijay, Ga., started reclassifying some of the money in its transaction accounts as savings deposits - and immediately cut reserves by $3.5 million.
Earnings from the reclassified money helped the $495 million-asset company produce double-digit earnings growth in 2003 and last year. (Attracting more low-cost deposits, cutting expenses, and booking more loans also helped.)
"Before we implemented this program, we had money just sitting in a closet, not earning a dime for us," said Darren M. Cantlay, the chief financial officer of the company, which owns Appalachian Community Bank. "Now we're making money off of it by making more loans and investing in more securities."
Without reclassifying its de-posits, Appalachian would have had to keep $6 million in reserves to cover its growth in deposits over the last several years, Mr. Cantlay said.
The Fed makes banks reserve 3% and 10% of transaction account balances so customers always have immediate access to their money. No such reserving is required for savings accounts and time deposits, since withdrawals are limited.
Deposit reclassification is not new; the Federal Reserve approved it in 1994. But for years big banks were the main practitioners, because their reserve requirements are so large, consultants say.
Now many community banks with substantial reserve requirements are also reclassifying. One reason may be that the necessary software has become cheaper.
"So many banks are looking for ways to increase their profitability, but they don't want to impact the customer with a lot of fees," said Douglas J. Ceto, senior manager of Ceto & Associates, a bank consulting firm in Suwanee, Ga. "This is a great way to turn nonearning assets into an earning assets."
His father, Nicholas Ceto Jr., helped develop the reclassification concept in the early 1990s. The firm he founded has helped more than 400 banks (including Appalachian) and credit unions reclassify their deposits, Douglas Ceto said.
Reclassification works this way: For each customer, a software program determines the percentage of money typically left in an transaction account after a withdrawal. That percentage can then be reclassified as savings, reducing the needed reserve for withdrawals from the account.
To maximize the sum reclassified, the bank divides each transaction account into two "subaccounts" - one checking, one savings - for accounting purposes. (The process is invisible to the customer, from whose perspective there is only one account.)
The bank can divert a high percentage of the account balance - typically 75% to 85% - into the savings subaccount at the beginning of each month and whenever money is deposited. It can transfer money out of the savings subaccount six times a month to cover withdrawals that exceed the balance in the checking subaccount.
On the seventh transfer it must put everything into the checking subaccount and reserve for the balance. The process starts anew each month.
"There's a renewed interest in deposit reclassification" now that markets are stronger and banks can get higher returns on their investments, said Mike Middleton, a senior manager at Moss Adams LLP, a Los Angeles accounting firm that helps community banks implement such programs and offers software to do it. "It's certainly worth analyzing whether you can take money out of reserves and put it into higher-yielding securities."
But deposit reclassification is not for every bank, said Anne Fuehrer, marketing manager at Precision Computer Systems in Sioux Falls, S.D., which also sells such software.
Deposit reclassification software is not cost-effective for those with less than $250 million or so of assets, she said; their reserve requirement is too small. Nor is the effort worthwhile without a significant sum in transaction accounts; banks heavy in certificates of deposit and other funding sources may not get much benefit.
David W. Harrop, a director in the Dallas office of RSM McGladrey Inc., said small banks that count the cash in their vault as reserves need to do a "vault study" to determine whether they could use that money after reclassifying their deposits.
"If a small bank has a lot of merchants as customers who need steady access to cash, then it can't really take advantage of the reclassification opportunity," Mr. Harrop said.
