Federal regulators yesterday approved final provisions of a new type of high-interest, insured account with a $2,500 minimum that banks and savings institutions can offer, starting Dec. 14, to compete directly with money market mutual funds.
The account, defined by the Depository Institutions Deregulation Committee, was ordered by Congress to aid the banking and thrift industries. It marks a significant step toward total banking deregulation. A further lifting of interest rate ceilings on medium-term certificates of deposit, as a well as a review of the whole deregulation process, is expected to be proposed at the next meeting of the DIDC on Dec. 6.
Besides $100,000 insurance, another feature of the account is what amounts to a 30-day guarantee on interest rates. Whereas money market funds guarantee their rates for only a single day, banks and thrifts may, if they wish, guarantee rates up to a month. Treasury Secretary Donald T. Regan said yesterday this provision would make the account "superior" to money market funds.
But another provision may detract from the account's appeal. If the average monthly balance falls below $2,500, interest will be paid on the entire account for that month at the NOW account rate, 5 1/4 percent.
Trade associations representing commercial and savings banks and savings and loan associations generally welcomed the new account. Several warned, however, that it could put pressure on earnings, particularly if many passbook account holders switch their funds to the higher yielding account or if competition results in a price war.
In October, Federal Home Loan Bank Board Chairman Richard Pratt predicted the new account would draw $100 billion away from money market funds. Pratt, who argued strongly against the $2,500 minimum at yesterday's meeting, said afterward the outflow from money market funds would be less.
Indeed, a recent study by Market Fact of Chicago suggested that only $22 billion would come from money market funds, compared with $100 billion from other accounts.
William Donoghue, publisher of Money Fund Reports, concurred and added that only the strongest banks -- and the weakest thrifts -- would be likely to pay rates high enough to cause customers to shift. The Investment Company Institute, which unsuccessfully sued to postpone the account, said it was still reviewing the DIDC decision. A spokesman confirmed insurance for money market funds is under study.
Regan, who chairs the DIDC, acknowledged at a news conference that interest rates paid would differ from region to region, depending on the competition. "No guru in Washington is going to set the rates for banks and thrifts." (Money market funds are paying an average of 8.8 percent.) He added that "only the marketplace will tell" if the new account is competitive with money market funds. Regan pledged that DIDC would review the account after some time and alter the terms if necessary to make it more competitive.
Half of all money market funds require an initial investment of $1,000 or less. The $2,500 minimum was a compromise proposed by Regan, who said he feared the adverse effect on institutions' earnings if there were no minimum, the suggestion of Pratt and National Credit Union Administration Chairman Edgar Callahan.
Federal Reserve Chairman Paul A. Volcker, however, complained in a barely audible voice that such action would "destroy M1," the major indicator of the money supply. The other voting member, Federal Deposit Insurance Corp. Chairman William Isaac, went along with the majority.
Investors would be permitted up to six transfers a month by check or draft out of the account. The minimum amount of a withdrawal by check is left up to the bank or thrift. However, there will be no restrictions on the size and frequency of withdrawals by mail, messenger, or in person. The DIDC will review telephone transfers at its next meeting.
Charges on overdrafts will be the same as for other customers. And institutions will not be permitted to lend money to customers to meet the $2,500 minimum and maintenance balance.