DDA Balance Reserve Requirement
DDA means Demand Deposit Account. A DDA is essentially your typical non-interest-bearing checking account you can open at just about any bank.
Prior to the Great Recession, the DDA Reserve Requirement balance for corporate accounts was ~10% of the Balance Subject to Reserve. Balance Subject to Reserve is the final balance used by financial institutions to compute the balance percentage they will deduct for any reserve requirement. This deducted amount is not subject to the Earned Credit Rate (ECR) of the account and thus not eligible for Earnings Allowance.
Why is this 10% reserve requirement (RR) deducted at all?
The Federal Reserve (Feds) required financial institutions to place 10% of their total deposits on reserve. This 10% requirement must be sat aside at the Fed so it is exempt from any interest-bearing activities the bank would have otherwise invested it in. Most financial institutions make money off the deposits of their account holders. You deposit funds into your account at Bank XYZ. Bank XYZ then takes those deposited funds and loan them out, at interest, to some other entity thus making money off your money you've allowed the bank to "hold" for you. If the funds are not loaned out, they are invested in various securities again potentially earning the bank a return off your money.
When the Feds implemented the 10% RR, this left the bank access to only 90% of their total deposited funds since they could no longer invest the other 10%. The banks were losing out on the investment opportunities and potential earnings for this 10% so instead of absorbing that loss they passed that loss down to their corporate account holders. Since the bank could not benefit from earning interest on the entire 100% of their deposits then neither would their corporate demand deposit account holders. This 10% deduction from the account holder's end is shown in the DDA Reserve Requirement balance which is 10% of the Balance Subject to Reserve balance.
So, what changed the 10% RR rules?
For some time, Regulation Q prevented corporate DDA holders from earning interest on their bank account balances. But, they are allowed an ECR which does not violate Reg Q since it is considered a "soft" interest. According to Wikipedia, Reg Q was enforced from 1933 following the Glass-Steagall Act to 2010 when it was repealed by the Dodd-Frank Act. What was also changed during the Great Recession was the Feds now allowing financial institutions to earn interest on their 10% RR.
No longer were financial institutions required to forego earnings on those funds sitting at the Fed. This now gave 100% of the bank's deposit balances the right to earn interest which made it difficult for those same banks to justify the 10% RR they had passed down to their corporate DDA holders. This change was eventually reflected on the EDI 822 files when the DDA Reserve Requirement balance was sent as $0.00. When one bank made the RR change there was a "hooray!" heard across the land (the small Account Analysis land). This resulted in a little nudge to other corporate DDA customers asking them, "why isn't your bank now subjecting 100% of your balances to ECR? Hmm."
Current day Reserve Requirement calculations...
The following balances may play a part in the DDA Reserve Requirement calculation:
- Compensating Bal Req-Credit Facility-Subject to Reserve
- Other Balance Subject to Reserve
Both Compensating Bal Req-Credit Facility-Subject to Reserve and Other Balance Subject to Reserve may be sent but I don't usually check for them unless there's a calculation issue which will cause other subsequent balances to be off.
We have already discussed this balance which, as its name states, is the balance subject to the reserve:
- Balance Subject to Reserve
The balance which displays any reserve requirement deduction is:
- DDA Balance Reserve Requirement
This topic opened the door for both soft and hard interest to be seen on the EDI 822 Account Analysis files. I have seen only one thus far so not enough data to compile an informative blog post. We shall see...
Happy Analyzing!
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