Working Together - Regulation D and Deposit Reclassification

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Deposit Reclassification, also known as a retail sweep program, allows financial institutions to reduce their Federal Reserve Bank reserve requirement. The Federal Reserve’s 12 CFR 204 Regulation D sets out uniform requirements for all depository institutions’ reserve balances - either as vault cash or as funds held with their local Federal Reserve Bank. Retail sweep programs reduce reserve requirements, which Regulation D sets out for financial institutions to observe. How do these two opposing items work together?

The key to this relationship is Regulation D reserve requirements only apply to transaction accounts where the account holder can make unlimited payments or transfers to and from the account. Furthermore, Regulation D restricts withdrawals from non-transaction ‘savings deposit’ accounts to just six per month, which limits a depository institution’s cash holding requirements, facilitates the banking business, and helps to effectively run monetary policy. Reserve requirement regulations are not applicable to non-transaction accounts. Regulation D’s non-reservable status for ‘savings deposits’ and transfer restrictions creates the foundation for Deposit Reclassification to exist.


That said, banking laws allow banks and credit unions to move funds between accounts. Deposit Reclassification implements these transfers between an account holder’s transaction and non-transaction accounts to sizably reduce a bank or credit union’s reserve requirements, often to amounts that are well below vault cash, and eliminates the need for reserve balances. However, just moving funds to a non-reservable status does not ensure a zero reserve balance; banks and credit unions must optimize their Deposit Reclassification on an account-by-account basis to minimize reserve requirements, free up cash for lending and investments, and maximize profits.

Savings Deposit Accounts Limited to Six Transfers per Month

Regulation D also imposes withdrawal limits on savings deposit accounts, which are commonly known as passbook savings accounts, statement savings accounts or money market deposit accounts (MMDA). It requires that a savings deposit account holder make no more than six transfers and withdrawals per calendar month or statement cycle of at least four weeks.

Transactions that count towards the ‘six transfer limit’ include online transfers, mobile transfers or over-the-phone transfers; automatic overdraft transfers to cover insufficient funds in other accounts; pre-authorized, automatic, scheduled or recurring withdrawals; electronic/ACH withdrawals, or transfers to another deposit account, third party or institution.

For example, if a savings deposit account provides overdraft protection but has reached the limit of six transactions (transfers/withdrawals), it would no longer provide overdraft protection and the account holder may be charged an “insufficient funds” fee. However, if the overdraft protection account is a line of credit (such as a bank issued credit card which is not affected by Regulation D) the overdraft will complete normally.

How Banks and Credit Unions Institute This Policy

The onus of enforcing this six-transfer limit falls on depository institutions. They implement this policy by a) preventing withdrawals or transfers from savings deposit accounts after the six-transfer limit has been reached, and b) adopting procedures to monitor savings deposit transfers and withdrawals. These procedures include contacting account holders after they’ve crossed the limit (on an ex post basis) and reminding them of the restrictions. If customers continue to exceed the six-transfer limit more than occasionally, even after they’ve been warned about it, the depository institution must either close the account and place the funds in a transactional account or take away transfer and draft capacities of the erring account.

An account that permits withdrawals or transfers in excess of the six-transfer limit is automatically classified as a transaction account for reserve computation purposes, regardless of the number of transactions actually made in such an account.

Regulation D Governance

The Federal Reserve audits depository institutions for compliance with Regulation D. Fed auditors review a bank or credit union’s implementation of Regulation D to see if its rules are being properly followed, and whether the institution has appropriate policies and procedures in place to identify, rein in and address Regulation D violations. For example, examiners may check to see if the bank’s early withdrawal penalties on savings deposits are at least equal to those required by Regulation D, and may verify the accuracy of penalties assessed for Regulation D infractions.

Should such Regulation D implementation procedures be lacking, inadequate or improperly implemented, examiners will censure the bank, require corrections before the next review, or impose penalties or other consequences.

How Regulation D Impacts Deposit Reclassification

To rein in reserve requirements and maximize liquidity in the banking system, the Federal Reserve permits ‘deposit reclassification’ whereby banks and credit unions transfer funds from transactional accounts (subject to reserve requirements) to invisible checking and savings sub-accounts (not subject to reserve requirements) through a ‘retail sweep’ program.

All Deposit Reclassification programs must adhere to Regulation D requirements. To facilitate Deposit Reclassification, each depositor’s checking account is split into a checking sub-account and a savings sub-account, with the customer’s prior authorization at the time the checking account is opened. This savings sub-account must be in compliance with all Regulation D requirements for a savings deposit account for it to qualify for non-reserve status. The reason the bank creates two sub-accounts, rather than just moving all funds into a savings account, is so that the financial institution can hold reserves on only the amount in the checking sub-account and not the entire checking account. The bank or credit union maintains a balance in the checking sub-account at a level that will cover the account holder’s pattern of transaction activity.

Now, should an account holder deplete funds in his/her checking sub account, the Deposit Reclassification program automatically initiates a transfer of funds from the savings sub-account to the checking sub-account to cover the transaction and projected future activity based on the account holder’s normal pattern of banking transactions. And at the six transfer, the bank or credit union will move the entire balance of the savings sub-account to the checking sub-account for the remainder of the calendar month. This way, the savings sub-account remains in compliance with Regulation D’s six-transfer limit. The depositor always has full access to the entire checking account balance for the entire month. The process in the sub-accounts remains invisible to each customer. .

Deposit Reclassification Must be Optimized for Every Account Holder

Transfer and withdrawal needs and patterns vary from customer to customer, and season to season. For example, students dependent on allowances or those living paycheck-to-paycheck may see money come into their accounts every month or every pay period, only to be almost fully withdrawn within that month; others, who earn more or have frugal habits, may make fewer withdrawals, so funds in their accounts may accumulate and grow month after month. So a student’s savings sub-account may hit its full limit of six transfers every month, but the high earner’s savings sub-account may never hit that limit.

So, to optimize their Deposit Reclassification programs, banks and credit unions must carefully review and analyze each depositor’s account history, and identify their unique pattern of deposits and withdrawals based on historical transactional data. FIs must then allocate an optimal amount of funds to the checking sub-account to cover projected monthly activity, and sweep the rest into the savings sub-account.

If the bank or credit union does not study individual patterns but arbitrarily allocates the same flat percentage to savings sub-accounts for all holders, it will fail at cash optimization and, consequently, not maximize its profits. Arbitrary allocations will also cause reserve balances to rise and defeat the purpose of Deposit Reclassification.

Simply put, a reclassification process needs to keep the maximum amount it can in savings sub-accounts so reserve requirements stay well below vault cash and allows the FI to keep just enough in checking sub-accounts so only five transfers or less are needed each month. And, because this needs to be done on an account by account basis to maximize profits, banks and credit unions must use financial analytics programs to fully automate and optimize Deposit Reclassification.


Curious to know how other banks and credit unions reclaimed their Fed balance?

Read their Case Studies

United Federal Credit Union Venture Bank
Traditions Capital Bank Richfield-Bloomington Credit Union
Biddeford Savings Bank