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U.S. House of Representatives,
Subcommittee on Financial Institutions
and Consumer Credit,
Committee on Financial Services,
Washington, DC.

    The subcommittee met, pursuant to call, at 2:10 p.m., in room 2128, Rayburn House Office Building, Hon. Spencer Bachus, [chairman of the subcommittee], presiding.

    Present: Chairman Bachus; Representatives Weldon, Bereuter, Lucas of Oklahoma, Kelly, Manzullo, Biggert, Toomey, Cantor, Hart, Capito, Ferguson, Rogers, Tiberi, Waters, Watt, Bentsen, Carson and Shows.

    Chairman BACHUS. The hearing of the Subcommittee on Financial Institutions and Consumer Credit will come to order. Without objection, all Members' opening statements will be made a part of the record.

    I now am going to recognize myself for an opening statement, and then the subcommittee Chairs and Ranking Members will make opening statements, which will be limited to five minutes, and the other Members will be recognized for three minutes for opening statements.
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    Today the subcommittee convenes to consider two separate but related proposals. One, repealing the current ban on the payment of interest on business checking accounts; and, two, permitting interest to be paid on funds that banks and other depository institutions are required by law to maintain at the Federal Reserve banks. The eyes of most Americans may glaze over at the mention of these two issues, yet both are of critical importance as the subcommittee seeks to continue the work of modernizing our financial system, which we began last year with the enactment of Gramm-Leach-Bliley.

    Like many of the provisions repealed by Gramm-Leach-Bliley, the ban on paying interest on business checking accounts is a Depression-era prohibition. Many think it has long since outlived its usefulness, and I myself have that opinion. When originally enacted in 1933, the ban was designed to protect small rural banks from having to compete for deposits with larger institutions based upon what they could offer customers as far as a higher interest rate. That was valid at one time. This policy justification is simply no longer relevant in a competitive environment where banks must compete not merely against each other, but against a host of non-bank financial firms offering a wide range of interest-bearing products.

    The prohibition on paying interest to business checking customers is one of the many factors contributing to a liquidity crunch for our Nation's small community banks. Faced in many cases with declining deposits coupled with strong demand for loans in their communities, small banks are caught in a vise, and are increasingly forced to seek funding from the Federal Home Loan Banking System and other alternative sources. Unable to earn interest on their checking account balances, small businesses in areas served by community banks have a powerful bottom-line incentive to take their business elsewhere. Not surprisingly, many choose to do exactly that, opening cash management accounts at brokerage firms or parking their assets in other interest-bearing vehicles outside the banking system.
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    Repealing the ban on interest on business checking accounts will allow banks to compete for such deposits on a more level playing field and promote the development of bank products and services geared toward a corporate clientele that is ill-served by the current prohibition.

    The second issue we will address today is somewhat the flip side of the first issue. Under current law, depository institutions are required to hold deposits at the Federal Reserve banks against transaction accounts maintained by the institution's customers. No interest is paid on these reserves. Banks have argued, persuasively in my view, that if the law is changed to permit interest to be paid on business checking accounts, a corresponding change should be made to authorize payment of interest on reserves that banks are required, by law, to maintain at the Federal Reserve banks.

    In addition, as we will hear in a moment from Federal Reserve Governor Meyer, I would anticipate that he will testify that failure to act in this area not only disadvantages banks, but it may at some point begin to have adverse consequences on the Fed's ability to conduct its monetary policy.

    Last year, the House passed legislation that would have repealed the prohibition on interest payments on business checking accounts, but the bill died in the Senate. Similarly, this subcommittee favorably reported legislation to authorize the Federal Reserve to pay interest on statutorily required reserves, but the full House never took up the bill. Two respected Members of this subcommittee, Mrs. Kelly and Mr. Toomey, have taken the lead this year in reintroducing these important proposals. I look forward to working with them and with Chairman Oxley to make sure that this Congress succeeds where past efforts have failed.
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    [The prepared statement of Hon. Spencer Bachus can be found on page 42 in the appendix.]

    Before recognizing Ms. Waters for an opening statement, let me welcome all Members to the hearing and extend a special welcome to Bob Gulledge, who is President of the Citizens Bank in my home State of Alabama, who last week was elected President of the Independent Community Bankers of America. I congratulate Bob on the appointment. We know you will serve Alabama well.

    Let me recognize Ms. Waters for any opening statement she would like to make.

    Ms. WATERS. Thank you very much, Mr. Chairman. I think you framed the issue quite well in your opening comments, and I do believe, because we have heard these issues before in this subcommittee that there probably is a consensus in this subcommittee of support for both issues.

    I am interested in two aspects of these issues that have not been discussed in any thorough way. One is how much does it cost? Is this going to be a cost to the Treasury; if so, how much and how is it calculated? And then I think we got into discussion once before on how will the customers benefit from the interest that banks would receive if, in fact, we would repeal existing law. I am going to be looking for comments and raising questions in those two areas and would be very appreciative for explanations that would help me to resolve some of the questions that I have in these two areas. And I would also like to know from the Feds how it helps them with monetary policy to be able to pay interest on what is, I guess, known as the sterile accounts.
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    So with that, Mr. Chairman, I will yield back the balance of my time.

    Chairman BACHUS. Thank you, Ms. Waters.

    At this time, Mr. Toomey, do you wish to make an opening statement?

    Mr. TOOMEY. Thank you, Mr. Chairman, and I would like to commend you for having this hearing so promptly and moving on this legislation. As you pointed out, last year we had a huge success when we passed the Gramm-Leach-Bliley Act, repealed archaic Depression-era banking laws, and here we are able to address a further step forward in repealing what many of us believe is an out-of-date portion of that Banking Act of 1933, the prohibition on paying interest on business checking accounts.

    It is just about time that we allowed regulation to catch up with the marketplace. The reality is that financial institutions with the wherewithal have maneuvered their way around this prohibition quite legally and appropriately, but it is a cumbersome process. They offer repos, implied in the form of services to customers, credits against bank charges. In fact, a quick search on the Internet, and we discovered numerous listings for banks offering, quote, ''interest on business checking,'' unquote.

    Unfortunately, of course, some banks cannot afford to purchase the software and the technology and the systems needed to circumvent these rules, and in any case it is very inefficient for banks to have to waste time and resources in inventing ways to get around unnecessary and inappropriate regulation.
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    So now it is well past time to repeal this ban and allow banks to develop products and services that will serve their customers, not the Government; allow businesses both large and small to have wider array of choices with their cash; allow small banks more tools to help them increase their core deposits, and frankly everyone will benefit from a repeal from unnecessary level of regulation.

    Early today I introduced the Business Checking Freedom Act which does repeal the prohibition on paying interest on business checking with a one year phase-in period. I would like to thank the other sponsors of the legislation, Mr. Kanjorski, Mrs. Roukema, Mrs. Hooley, Mr. Ney, Mr. Gonzalez, and Mrs. Capito. I took forward to the testimony of the witness. Thank you, Mr. Chairman.

    Chairman BACHUS. Ms. Carson.

    Ms. CARSON. Thank you very much, Mr. Chairman, for moving expeditiously on this issue concerning interest of the business demand deposits and permit payments of interest on sterile reserves. I could only replicate what has already been said very eloquently, so let me suggest then that I would use my limited time to say that we are honored today to have Mr. David Bochnowski from Munster, Indiana, the fine State of Indiana. For more than two decades, Congress has considered legislation that could repeal the ban on payment of interest or business demand deposits, and now we are here today to hopefully move forward in addressing an archaic rule. It is my firm belief that with people such as David Bochnowski present here today, that we will be able to take further steps toward resolving the issue.

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    Most of you, no doubt, know that Mr. Bochnowski currently serves as Chairman of the America's Community Bankers, and has served as its director since 1994. Yet this position represents only one chapter of a life dedicated to public service. This gentleman from my State began his career as a special assistant to my good friend, who was our senator at that time, Senator Birch Bayh. Mr. Bochnowski later served as a law clerk for the U.S. district court in Indiana's southern district. He served as a trustee for Munster Community Hospital, as a commissioner for the Chicago Gary Airport Authority, and also served his country with valor in Vietnam. So it is a pleasure, Mr. Chairman, and Members of this subcommittee, to introduce to you my friend, Mr. Bochnowski here, who is scheduled for the second panel, the discussion. I yield back.

    Chairman BACHUS. Thank you, Ms. Carson.

    Ms. Kelly, do you wish to make an opening statement?

    Mrs. KELLY. Thank you, Mr. Chairman. This afternoon, as I was walking over here, I heard the signs of spring. I heard the birds coming back and I noticed the buds emerging on the trees, and now I see Governor Meyer here before our subcommittee to talk about interest on business checking accounts, and sterile reserves, and that is an additional true signal that spring is here, don't you think?

    So Governor Meyer, we welcome you and thank you very much for coming back to talk with us about this. I want to quickly thank Chairman Bachus and Ranking Member Waters for agreeing to hold this hearing today. These issues are very important and they relate to another growing issue that we would hold hearings on in this Congress, and that is the ability of community banks to attract sufficient deposits to ensure safe and sound operation of the banks.
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    The question I would like to explore with the witnesses today is how will the repeal of the prohibition of paying interest on corporate demand deposits affect the bottom line of the banks? I have introduced H.R. 974, the Small Business Interest Checking Account Act of 2001, and a Senate companion has been introduced today by Senator Chuck Schumer. This legislation contains three parts: first, it gives banks the authority to increase their sweep activities from the current six times a month to 24; second, it authorizes the Federal Reserve to pay interest on reserves; and third, it gives the Federal Reserve greater flexibility in setting reserve requirements. In crafting this legislation, I have consulted with the Federal Reserve, the Treasury Department, and the groups before us today to ensure that this legislation will be acceptable by all. In addition, Congressmen Toomey and Kanjorski have introduced legislation to repeal the current prohibition on business checking accounts.

    As has occurred in the past year, we anticipate these initiatives to be merged when we mark up the legislation, and in the course of the length of the transition period, these are going to be the biggest issues. So I look forward to discussing these issues with the distinguished witnesses that we have today, that have taken their time to join us. And I yield back the balance of my time.

    [The prepared statement of Hon. Sue W. Kelly can be found on page 44 in the appendix.]

    Chairman BACHUS. Thank you, Mrs. Kelly.

    Mr. Cantor. I will be sure to say to all Members, please speak in the mike. That wasn't intended for you, Mr. Cantor.
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    Mr. CANTOR. I am sure I need no help. Thank you. I have no formal opening statement. I would like to extend my personal welcome to the panel witnesses, especially to Mr. Thomas P. Jennings, the Senior Vice President and General Counsel of First Virginia Bank from my home State, whose bank has a strong presence in the 7th District of Virginia in Richmond. Welcome, Mr. Jennings.

    Chairman BACHUS. Thank you. Do we have anybody here from Missouri? Maybe we could recognize him next.

    Mrs. Hart from Pennsylvania.

    Ms. HART. Thank you, Mr. Chairman. I also don't have any formal opening statement. I am pleased for the opportunity to be here at the hearing today and hear from such a distinguished panel on the issue. As a freshman, I am not as experienced as some of the others on some of the issues nationally when it comes to banking and financial services. However, I was very much involved on a State level as a State Senator, and I will be very much interested to see the private sector panel discuss these issues and answer some of the questions we have.

    My main concern is basically how little, and normally how little can Government become involved in the decisions made by financial institutions without causing them harm. Because my angle is basically that if we can regulate less, I would prefer to do it. However some questions have been raised to me from some of those involved on different ends of banking and different types of banking and the communities I represent about whether or not this is a good idea, and if it is a good idea at this time, I will be interested in hearing.
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    So for any of the—especially panel two that is here, I will be very interested in hearing your response to those questions. And just general questions of interest I think to the Members of the subcommittee. Mr. Chairman I am honored obviously to be a part of this subcommittee and pleased to be here, and also not to discount panel one, but I will also be interesting in hearing really directly the amount of control they believe that they need to have when it comes to banks, especially making decisions about interest. Thanks, Mr. Chairman.

    Chairman BACHUS. Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman. I would thank you for holding this hearing. I hoped we would have disposed of this issue in the last Congress, but we didn't, and I would hope we can dispose of it in this Congress rather quickly. It seems, at least on this side of the street, we are generally in agreement, so I hope we are able to move quickly on this. I yield back the balance of my time.

    Chairman BACHUS. Thank you, Mr. Bentsen.

    Chairman Oxley, you are recognized at this time.

    Mr. OXLEY. My opening statement is making its way up to the podium as I speak, and so I would defer to other Members with an opening statement until such time as it may arrive, and I think you would rather have that than me making it up on the fly.

    Chairman BACHUS. And we earlier said, without objection, we would make those statements part of the record without the spoken word.
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    Mr. OXLEY. That would be a brilliant idea, and I would agree with that and ask unanimous consent that we do the same.

    Chairman BACHUS. So moved. Thank you, Mr. Chairman.

    Mr. Watt.

    Mr. WATT. Thank you, Mr. Chairman. I will be brief. I have expressed my opinions about this in the last term of Congress, and have been a long supporter of not having money sitting around doing nothing, either in checking accounts or sterile reserves or otherwise. And I hope we are going to do something in addition to having hearings on it this time, and actually move some bill that will accomplish those objectives. Thank you.

    Chairman BACHUS. Thank you, Mr. Watt. Are there other Members of the subcommittee who would like to make opening statements? If not, Chairman Oxley.

    Mr. OXLEY. Mr. Chairman, I think your initial idea was good that the statement be made part of the record. I just want to commend you on holding this hearing. This is a very important issue. And I appreciate the participation of the Members, particularly the Members who have been through this issue before, the gentleman from North Carolina, Mr. Watt, yourself and others, Mrs. Kelly, and we look forward to the testimony from the witnesses and hopefully a strong bipartisan support for this legislation. I yield back.

    Chairman BACHUS. I thank you, Mr. Chairman. We did mention, as you referred to, that Mrs. Kelly and Mr. Toomey had actually sponsored the legislation last year and Mr. Watt, I recognize your role. At this time we will recognize the first panel made up of Governor Laurence Meyer, Federal Reserve Board Governor of the Federal Reserve System, who has been before this subcommittee four years in a row to testify about this subject. So we would expect a pretty smooth statement, I would think. And then, Acting Under Secretary of Domestic Finance for the Department of the Treasury, Donald Hammond. Secretary Hammond, we welcome you and Governor Meyer. And Governor Meyer, if you would like to lead off.
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    Mr. MEYER. Thank you. Mr. Chairman, Representative Waters, and Members of the subcommittee. The Federal Reserve Board continues to strongly support legislative proposals to authorize payment of interest on demand deposits and interests on balances held by depository institutions at Reserve Banks. As we have previously testified, unnecessary restrictions on the payment on interest on demand deposits and balances held by Reserve Banks distort market prices and lead to economically wasteful efforts to circumvent these restrictions. Authorization of interest on balances at Reserve Banks would also help to ensure the continued effectiveness of current procedures for implementing monetary policy.

    The Board also supports obtaining an increased flexibility in setting reserve requirements, which would allow it to consider reducing the regulatory burden on depositories to the extent consistent with the effective implementation of monetary policy. As you know, the Federal Open Market Committee formulates monetary policy by setting a target for the overnight Federal Funds rate, the interest rate on loans between depository institutions of balances held at their accounts at Reserve Banks.

    As we have previously testified, the issue of potential volatility in the Funds rate has arisen in recent years because of substantial declines in required reserve balances owing to the implementation of automated sweep programs from reservable checking accounts to savings accounts that are not subject to reserve requirements. Nevertheless, despite a much lower level of required reserve balances, no trend increase in volatility has been observed to date. In part, this stability reflects the increasingly important role of contractual clearing balances. These clearing balances are the amounts that depositories contract to hold in their accounts at the Federal Reserve in addition to funds that will meet reserve requirements. Contractual clearing balances earn implicit interest in the form of credits that may offset charges for Federal Reserve services, such as check clearing.
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    To prevent the sum of required reserves and contractual clearing balances from falling even lower, the Federal Reserve has sought authorization to pay interest on required reserve balances and to pay explicit interest on contractual clearing balances. Such interest payments could help maintain the level of these balances and forestall any potential increase in the volatility of interest rates. Authorization of increased flexibility in setting reserve requirements would also be desirable as it would allow the Federal Reserve to consider exploring the possibility of reducing reserve requirements below the minimum levels currently allowed by law. Such reductions would further remove incentives for wasteful reserve avoidance practices.

    To ensure the continued effective implementation of monetary policy with lower reserve requirements, however, we would need authority to pay interest on contractual clearing balances. Indeed, while the best outcome would be an authorization to pay interest on any balances held at the Federal Reserve, if the budget costs of interest on required reserve balances continues to inhibit its passage we would support a separate authorization of interest on contractual clearing balances which would have essentially no budgetary cost.

    Another legislative proposal that would improve the efficiency of our financial sector is elimination of the prohibition of interest on demand deposits. This prohibition distorts the pricing of transaction deposits and associated bank services. Some small businesses receive no interest on their deposits. In competing for the liquid assets of other businesses, banks set up complicated procedures to pay implicit interest on compensating balance accounts. Banks also spend resources and charge fees for sweeping the excess demand deposits of larger businesses into money market investments on a nightly basis. Such expenses would be unnecessary if interest were allowed to be paid on both demand deposits and reserve balances that must be held against them.
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    In summary, the Federal Reserve Board strongly supports legislative proposals to authorize the payment of interest on demand deposits and on balances held by depository institutions at Reserve Banks, as well as increased flexibility in the setting of reserve requirements. We believe these steps would improve the efficiency of our financial sector and better ensure the efficient conduct of monetary policy in the future. Thank you.

    [The prepared statement of Hon. Laurence H. Meyer can be found on page 45 in the appendix.]

    Chairman BACHUS. Thank you.

    Mr. Hammond. Let me say to both witnesses that without objection, your written statements will be made a part of the record.


    Mr. HAMMOND. Thank you, Mr. Chairman, Chairman Bachus, Representative Waters, Members of the subcommittee. I appreciate this opportunity to appear before you this afternoon. I appreciate this opportunity to present the Treasury Department's views on repealing prohibitions on the payment of interest on business checking accounts, and on permitting the payment of interest on reserve balances that depository institutions maintain at the Federal Reserve. The Treasury Department supports permitting banks and thrifts to pay interest on business deposits. While sympathetic to many of the arguments in favor of permitting the Federal Reserve to pay interest on reserve account balances, we are not prepared to endorse this proposal at this time.
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    The Treasury Department has consistently supported provisions repealing the prohibition on paying interest on demand deposits. Repeal of this prohibition would eliminate a needless Government control on the price that banks must pay for business deposits consistent with the earlier elimination of Regulation Q rate ceilings on other deposits. The result should be more efficient resource allocation. Most proposals that would have allowed banks and thrifts to pay interest on demand deposits would have delayed repeal of the current prohibition for a number of years and provided for transitional mechanisms. The Treasury Department continues to prefer a relatively quick repeal on the prohibition on paying interest on demand deposits obviating the need for special transitional arrangements.

    The Federal Reserve Act requires depository institutions to maintain reserves against certain of their deposit liabilities. Institutions typically meet these reserve requirements through vault cash, and a portion of their reserve balances at a Federal Reserve bank known as required reserve balances. Depository institutions may voluntarily hold reserve balances above the amount necessary to meet the requirements which are called excess reserves. Required reserve balances and excess reserves held at the Federal Reserve do not earn interest, hence they are referred to as stale reserves. Since the beginning of 1990s, required reserve balances at the Federal Reserve banks have declined by 83 percent. Three factors may be primarily responsible for the decline: one, regulatory actions taken by the Federal Reserve in the early 1990s reducing reserve requirements; banks' growing use of new products and technology, such as retail sweep accounts to minimize required reserves; and growth in the use of vault cash to meet reserve requirements as increased ATM usage has increased the need for such cash. The proportion of reserve requirements met by vault cash has risen from 44 percent in December of 1989 to 85 percent in January of this year.
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    The three principal grounds for paying interest on reserve balances are to: one, promote economic efficiency; two, facilitate monetary policy; and three, lower cost to the banking industry.

    Permitting the payment of interest on reserve balances might lead to greater economic efficiency. Banks have expended considerable resources to avoid holding non-interest-bearing required reserve balances. If banks earned interest on these reserve balances, they would be less likely to expand the use of sweeps and might unwind some existing sweep programs.

    As you heard from the Federal Reserve, the decline in required reserve balances could lead to greater short-term interest rate volatility, although such volatility is not a serious problem at present. For various reasons, the demand for balances to meet reserve requirements is more stable than the demand for balances to clear transactions through the Federal Reserve Fedwire system. Thus, the smaller the required reserve balances, the greater the role that less predictable daily clearing needs of banks would have in determining the demand for reserves. This may make it more difficult for the Federal Reserve to supply the amount of reserves consistent with its Federal funds rate target.

    Banks have long contended that the cost of reserve requirements, forgone earnings, put them at a competitive disadvantage relative to non-bank competitors that are not subject to reserve requirements. Yet the foregone earnings that depository institutions currently incur through reserve requirements must be viewed in their context to the overall relationship to the Federal Government, including benefits derived from Federal deposit insurance and access to the Federal Reserve payment system and discount window.
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    The Office of Management and Budget, a congressional budget office, have, in the past, estimated that paying interest on required reserve balances would cost approximately $600 million to $700 million over a five-year period. Both the OMB and the CBO estimate take into account the effect on tax revenues from depository institutions that receive interest. Some proposals have provided for an offset to the budget cost by transferring a part of the Federal Reserve surplus to the Treasury. It is true that in some previous years, budget accounting rules have permitted the transfer of Federal Reserve surplus funds to the Treasury to count as receipts that would offset the cost of other programs. Yet over time, transfers of the surplus do not result in budget savings.

    In sum, Congress should act to repeal prohibitions on paying interest on business checking accounts at banks and thrifts. This would eliminate unnecessary restrictions on this institution's ability to serve their commercial customers. Proponents of paying interest on reserve balances maintained at the Federal Reserve have put forth a number of reasons in their favor.

    As a general matter we are sympathetic to many of the arguments put forth by those proponents, particularly with respect to monetary policy. At the same time, however, we are also mindful of the budgetary costs associated with this proposal which would be significant. The President's budget does not include the use of taxpayer resources for this purpose. At this time, then, the Administration is not prepared to endorse that proposal. I appreciate the opportunity to appear before you and I am happy to respond to any questions you may have.

    [The prepared statement of Donald V. Hammond can be found on page 56 in the appendix.]
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    Chairman BACHUS. Thank you.

    I appreciate the testimony, summary of the testimony from the first panel, and at this time we will permit Members five minutes to ask you any questions they may have. And I am going to go ahead and read down the order that we are going to do this in the order that the Members arrived. I am going to go from Majority, we will alternate, but on the Majority side, Mr. Cantor, Mr. Toomey, Mrs. Biggert, Ms. Hart, Mr. Lucas, Ms. Kelly, Mr. Rogers, Mr. Bereuter, Mr. Ferguson, Mr. Tiberi, Mrs. Capito, Mr. Manzullo and Mr. Weldon.

    On the Minority side, Ms. Waters, Ms. Carson, Mr. Bentsen, Mr. Watt, Mr. Shows. If I note that a Member is no longer at the hearing, I will just simply go to the next Member down, and at this time I will recognize Mr. Cantor for questioning.

    Mr. CANTOR. Thank you, Mr. Chairman.

    I would like to direct this question to Mr. Hammond, and really ask you, I think, a question of fairness and the fact that if we are going to lift the ban on the interest on business checking, why is it that banks couldn't receive interest on their sterile reserve deposit? And to me, there is this question of the cost of funds versus getting return on the funds deposited. How do you answer that, leaving aside sort of the budgetary concern of the Administration?

    Mr. HAMMOND. I think from a standard of balance and equity, the match of payment of reserves on the liabilities side combined with the payment of interest on business checking gives the opportunity for balance within the system, and I think with that regard, the two proposals make sense looking at them together. As I said in my testimony, we are quite supportive of a lot of arguments related to the cost or to the proposal for paying interest on reference. I think the final component is that there is a cost to be important by the general taxpayer, related to the fact at that time, Federal Reserve system returns its earnings to the Treasury on an annual basis. As a result, the payment of interest on reserves does, in fact, create a cost to the general funds.
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    Mr. HAMMOND. Leaving aside that provision, I think that the proposal to pay interest on the reserves is one that we support from the standpoint of the other provisions. But obviously, the cost is a significant issue.

    Mr. CANTOR. Thank you, Mr. Chairman. I yield back the balance of my time.

    Chairman BACHUS. Ms. Waters.

    Ms. WATERS. Thank you, Mr. Chairman.

    As I indicated in my opening remarks, I wanted to know more about the cost to the public, and while I don't want to get you all embroiled in the discussion about the $1.6 trillion tax cut that we are discussing here, the fact of the matter is some of us are very concerned about how we pay for it. If you are suggesting that paying interest on the sterile reserves could cost us $600 to $700 million over a five-year period of time, could you calculate that out over a ten-year period of time? We are dealing with a tax cut over a ten-year period of time and we are looking at, well basically, you know, how are we going to do this? So what does this calculate out to? It is double more this amount, or it is more than this amount over a ten-year period of time?

    Mr. HAMMOND. I am not aware of any estimates that extend beyond the five year horizon that both OMB and the Congressional Budget Office have independently performed. I suspect that what you would see is a fairly even balance unless you saw things such as growth in, for example, clearing balances which, if allowed to pay interest on those, the Federal Reserve System may very well find that there is a reduced cost from the overall proposal.
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    Ms. WATERS. Also, I would like to ask you, as I am going to ask Mr. Meyer if I have time, what—if there is additional earnings in the flow of income on the payment of interest from the Feds to the banks, how can consumers benefit from this? Did we discuss this before, what the banks do with this additional revenue and whether or not it would lower interest rates? What can it do for the average consumer?

    Mr. HAMMOND. I think any opportunity to improve the profitability of financial institutions certainly has to have indirect benefits for consumers, because obviously, the increased earning capacity of the financial institution should lead to reduced fees in certain areas in their business. How those reductions in fees would flow through on an average basis I think would vary from institution to institution.

    Ms. WATERS. Should we support this repeal of law that would allow for the payment of interest on these accounts in the Federal Reserve accounts, the sterile accounts? Should we encourage, in some way in the legislation, the banks to reduce fees or to show how their customers are benefiting from this new revenue?

    Mr. Meyer.

    Mr. MEYER. I would not particularly encourage that. I would leave it to the competitive financial system we have that would induce banks to pass along the benefits of interest on reserves in a variety of ways, and I wouldn't want to instruct them precisely on how to do that. I think the most likely outcome would be somewhat higher interest rates on the transaction deposits that are no longer backed by the sterile reserves. It could be that banks might charge somewhat lower interest rates on some loans or they might charge somewhat lower fees for some services. There are a whole variety of ways that they could adjust, but I wouldn't want to micromanage that and tell them this is the way you ought to adjust. It is up to bank management, it is up to the competitive forces in the markets, to determine precisely what those adjustments are.
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    Ms. WATERS. If you had to make the argument to the taxpayer who would be told that it would be a cost to the taxpayer to pay interest on these accounts, how could you tell the taxpayer that they were going to benefit, if we are not going to encourage in some way, some broad way, how could you tell the taxpayers that yes, you got support, the bank is getting a new source of revenue; no, you are not going to mandate in any way that the customers benefit from that; but yes, it is going to cost them money for this to happen, how do you reconcile that way?

    Mr. MEYER. Well, three ways. First of all, that it would reduce the necessity of banks engaging in wasteful spending to get around these restrictions. Setting up a sweep account has no social benefits at all. It is just to avoid a restriction. So that is a total benefit to society that that money isn't wasted. Second, I would tell them that they should look forward to, and could reasonably anticipate, that they will get either higher interest rates or face lower loan rates, because that will be an outcome of this—a natural outcome of this due to our competitive system. And third, I would tell them that they can look forward to continued effective monetary policy, because this will also maintain the effectiveness of our current operating procedures.

    Ms. WATERS. Thank you. I believe my time is up.

    Chairman BACHUS. Thank you.

    Mr. Toomey.

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    Mr. TOOMEY. Thank you, Mr. Chairman.

    Actually, perhaps if both of you gentlemen could address this briefly. You know it is true we are working on a, in my view, unfortunately modest tax relief package of $1.6 trillion dollar. Some of us would like to see considerably larger. It is all focused on individual tax relief, as you gentlemen very well know. But when it comes to corporate taxes, it is not the failure to pay interest on stellar reserves in a way, a hidden or implicit tax on a category of assets rather on the profitability of a firm, in other words it is a cost imposed by Government that bears no relationship to the profitability of the firm, like most of our methods of tax incorporations, but rather deals with a category of assets, and isn't that, in many ways, an inefficient way to tax corporations?

    Mr. MEYER. Well, it is, it is often referred to as an implicit tax, and I think it is a particularly inefficient tax because it generates these totally wasteful expenditures, and so I quite agree.

    Mr. HAMMOND. I would certainly agree that it is a cost that is unrelated to other activities of the business. It is also a cost that, as Governor Meyer pointed out, can be managed through incurring other costs to avoid that type of relationship. That would seem to be, all things being equal, not the most effective way of going about collecting that type of revenue.

    Mr. TOOMEY. So if you had to prioritize the kinds of taxes as a general matter, that if we were looking at ways to relieve the tax burden on the corporate sector of our economy, for instance, would this be a kind of tax that might deserve a priority, because it has additional negative consequences that go with it above and beyond those negative consequences that are associated with any kind of tax?
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    Mr. HAMMOND. I think, speaking from my experience, and keep in mind I am not certainly an expert on taxation by any means. I think any time you try to prioritize various costs against each other, you have to see the complete list. All I could tell you is that it does appear to be a very inefficient way of generating revenue. Where that would rank in a listing of priorities of various other types of business expenses or business taxes, I don't know.

    Mr. TOOMEY. Moving on for a moment to interest on business checking accounts, could either of you maybe develop a little bit your thoughts on the nature of and the costs associated with the ways that banks have had to find ways around this decades-old prohibition?

    Mr. MEYER. Well, there are several ways. One of them is setting up very complicated procedures to pay implicit interest through compensating balances. These are fairly complex arrangements. You have to keep track of a lot of different services that are being provided to the businesses to compensate them for the failure to pay interest on the demand deposits. That is a very inefficient way relative to simply paying interest on demand deposits.

    A second way is setting up sweep accounts where balances are taken out of the demand deposit accounts and swept into either open market instruments or into savings accounts that pay interest. Now, that can be done, but there is a fixed cost of setting up these arrangements. That can be quite large, and there is a maintenance cost every year of implementing those. So these are very costly procedures that would be totally unnecessary if we allowed the payment of interest on demand deposits.

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    Mr. HAMMOND. I would agree with that analysis.

    Mr. TOOMEY. OK. My last question, if time still permits, is your—each of your thoughts on a phase-in period. What is the appropriate period of time the phase-in a repeal of this prohibition? There has been suggestion that it be immediate and some have suggested several years. I am just curious to have the benefit of your thoughts on this.

    Mr. HAMMOND. I think following up on your last question, Treasury feels that the shorter the transition period, the better. In fact, even no transition period would be appropriate. From the standpoint that the longer that you have of a transition or special arrangements for transition processing, you create some of the same costs and inefficiencies that the sweep programs and other comparable programs have today.

    Mr. MEYER. Well, I would agree. I think our preference would be for either no transition or a very short transition. Otherwise, what we are doing is maintaining the competitive advantage of some players in the market, the larger banks that have sweep programs already relative to the smaller banks that don't, providing differential access to the larger firms that can take advantage of compensating balances on sweep accounts relative to the small businesses that can't. We have said, however, in the interest of achieving a consensus and a compromise, if there was a short transition period, we certainly wouldn't object to that.

    Mr. TOOMEY. Thank you both.

    Mr. Chairman, I yield the balance of my time.

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    Chairman BACHUS. Mr. Toomey, again, we want to thank you for your diligence on this legislation that we passed a few years ago.

    At this time I will recognize Ms. Carson.

    Ms. CARSON. Yes. Thank you, Mr. Chairman.

    I want to try to be quick with this. We passed legislation that allows automatic electronic transfers of a lot of Federal checks, like Social Security checks, civil service retirement, and so forth, which obviously arrive at your institutions the last day of the month prior to the time they are due, first day of the month. They don't collect until the third of the month, and so forth. The banks are obviously, at that particular time, drawing a lot of interest on that deposit for those couple of days, and so forth, that they happen. Who do you pay that interest to? The money's sent there by the—pardon me, not you, but how is that interest money paid once it is received by the financial institution? Because it was orchestrated by the Federal Reserve, you know what I am saying? I am glad you do, because I can't figure out what I am saying.

    Mr. MEYER. Well, there is a period after which it must be credited to the account of the person who is receiving that deposit, and from then on the interest goes to the deposit owner.

    Ms. CARSON. Right. But during those 3 or 4 days that the bank has the money, that the customer can't draw from, the money's there but the customer can't draw from it.
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    Mr. HAMMOND. Actually, in the normal course with electronic payments, we make the cash available the same day that it is available to the consumer, to the financial institution. What frequently happens is that the financial institution gets advice of the payment in advance of the availability of the funds, but, for example, for a Social Security payment, where it would be available on the third of the month, which would be the date that the check would normally arrive, if they are getting an electronic payment, they immediately have available funds in their account on the third of the month for that type of payment.

    Ms. CARSON. I want to ask you, I know this has nothing to do with this legislation on interest being on checking accounts, but I did want to say, and you sort of touched upon it, one of the principal arguments for two- or three-day delay on interest-bearing checking accounts, it is banks who currently offer sweep accounts and other alternatives to interest-bearing checking accounts, will need time to unwind their current arrangements with their business customers?

    Now, I know you have been sort of talking about that. But with a long transition period with the 24 transactions per month MMDA, that is the money market deposit account, financial institution also incur cost at establishing 24-hour transaction MMDAs. Then at the end of the transaction period, those arrangements would have to be unwound. Doesn't a long transition period needlessly increase the cost and burdens for both financial institutions and their business customers?

    Mr. MEYER. I would agree. I believe it does.

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    Mr. HAMMOND. I would say that a transition period doesn't offer any benefits to the customers or to those institutions who today don't have other types of institutional arrangements. So I don't see any justification for an extended transition period.

    Ms. CARSON. But is your belief that if this bill becomes law then you don't have to, you won't have the concern about the transition periods and——

    Mr. MEYER. No, I think that banks could manage that process very effectively. I don't think it is, by any means, a necessity to have a transition period, but it is one of the balancing forces out there. There certainly are going to be banks that say they have entered into relationships with customers that build in these sweep accounts. These sweep arrangements have a certain period over which they hold. The banks would prefer a transition period that would allow them to get the benefit of these arrangements. But on the other hand, during that period, these will be all the other banks that don't have the opportunity to have sweep accounts and all the small businesses that won't have opportunity to have interest-bearing accounts. So we have to balance those two forces.

    Ms. CARSON. Yeah, I favored the legislation, so don't—you know, misread my inquiry.

    Mr. Chairman, I would yield back.

    Chairman BACHUS. Thank you, Ms. Carson.

    Mrs. Biggert.
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    Mrs. BIGGERT. Thank you, Mr. Chairman.

    Mr. Hammond, one of the witnesses that we will hear from later today in his written testimony has said that implementing interest rates on the business checking accounts could, in fact, hurt small banks disproportionately, because they will be forced to raise additional deposits to offset the costs of moving money from interest-free deposits to interest-bearing accounts, but we are also—that this will help community banks retain commercial checking accounts. Do you believe that small banks could be hurt by allowing interest to be paid on interest checking accounts? It will help them to retain large business accounts and keep those large business accounts from jumping over to other financial service industries?

    Mr. HAMMOND. I think the ability for banks to pay interest on business checking accounts gives small financial institutions, in particular, an increased competitive advantage that they don't otherwise have today. They don't have the capability of offering some of the more complicated or more costly sweep relationships, nor do they have the ability to compete effectively against, for example, securities firms.

    So I think over the long term, this provision would allow small banks to retain existing checking and deposits and put them on a more equal footing to be able to obtain additional deposits going forward.

    Mrs. BIGGERT. But will this still force them to raise, they will have the raise their deposit level?

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    Mr. HAMMOND. I think obviously there will be an increase in cost as they phase this from however they approach the payment of interest on business checking accounts, but the offset to that is that today, for business customers who want interest on their checking deposits, they have gone somewhere else if they can't find that service at the small bank. So as a reality, they may, in fact, find they are able to lure small businesses back into their fold in that environment.

    Mrs. BIGGERT. Mr. Meyer, would you agree with that?

    Mr. MEYER. Yes, I also think the main beneficiary would be smaller banks and that, in addition, while they would pay interest on these deposits, deposits are still a relatively low cost source of funds to community banks, and they need the opportunity to compete effectively for them with non-banks.

    Mrs. BIGGERT. So you wouldn't see them losing the business accounts to other financial services?

    Mr. MEYER. No. To the contrary. Now I think one should understand that there are banks who have customers that are relatively insensitive to interest rates and are now getting zero on their balances. I can understand that some banks would like to have a situation where that could continue. I am not sure that that is in the public interest, so I would support the legislation.

    Mrs. BIGGERT. Thank you.

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    Thank you, Mr. Chairman. I yield back.

    Chairman BACHUS. Thank you, Mrs. Biggert.

    At this time, Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman.

    Governor, as I said at the outset, I had thought we had done this already and we had on our side of the Capitol, and so hopefully we can do it now. And I look at the panel that is coming after this and I didn't get through all the testimony, but I am still looking for somebody who is opposed to this, but I guess I also want to say I agree with you on the transition period. I don't see any reason why sweep accounts that have been structured for banks to pay interest to their customers can't be unwound. These are all short term sweep accounts anyway, so they can remain liquid, and I would hope that if there is a problem, that somebody will present that to the subcommittee so we can look at it. But it seems to me that there is sufficient time to make a transition for this. In addition, it would seem to me that there would become a very apparent marketplace in the future for providers of sweep accounts to smaller banks who aren't going to want to do this on their own, that this will be a service that they will buy. So I don't see where anybody's ox gets gored in this process.

    Let me ask you about your discussion in your testimony, though, regarding reserve requirements. You talk about maybe this providing you with an opportunity with the Fed, the opportunity if Congress is willing to, I guess, reduce the band between the 8 and 14 percent to a lower percent, but you also say currently, the Fed is, I think, a 10 percent reserve requirement level, so you are not at the low end anyway. Some of my colleagues have proposed a complete repeal of the reserve requirement.
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    In your testimony, you sort of hint at that, but I am not sure if you go as far. So my first question would be, are you arguing that we ought to repeal the reserve requirement, or are you arguing that we ought to just give you greater flexibility so the Fed can explore other means with which to implement monetary policy?

    And secondary to that, given the possibility that we might actually pay down all of the Federal debt, publicly held debt, and of course, it is not a done deal yet, but it is an outside possibility, I realize the Fed has undertaken a study of other types of securities with which to conduct open market activities. In the event that there is not a sufficient replacement for the Fed to conduct open market activities to the tune that you do currently, would it be wise to eliminate reserve requirements altogether as a tool of monetary policy, or is it so antiquated that it really doesn't do any good?

    Mr. MEYER. In the past, we have been concerned that the total of required reserves and contractual clearing balances would fall to such a low level that it would impede the effective operation of monetary policy.

    Now, in fact, as it has fallen, we haven't seen an increased volatility in the Federal Funds rate. Now we have the prospect that if we pay interest on required reserves and we pay interest on contractual clearing balances, these deposits will grow, although we don't really need them higher. So if they grow, it would provide us with an opportunity to lower the required reserve ratio. So one of the benefits here is we might be able to have the same level of deposits with the same effectiveness of monetary policy, and lower required ratios at the same time.
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    Whether that would be possible would depend on the experience once we implemented interest on required reserves and interest on contractual clearing balances, seeing how much they would grow, and then we would have to very gradually see to what extent we might be able to lower reserve requirements.

    Mr. BENTSEN. If I might interject before my time is up, I think I know where you are heading in saying that instead of having a mandatory reserve requirement you could, in effect, buy the reserves that you need to conduct monetary policy, and I appreciate that, but is there an opportunity where an imbalance in the economy and an imbalance in interest rates might otherwise cause banks to put their funds elsewhere than at the rate that the Fed is paying, or would the Fed be paying market rates so there wouldn't be any spread between the public market and the Fed market?

    Mr. MEYER. I think we would be paying the rate where we could control the total level of the required and contractual balances to achieve the stable and predictable level that is necessary for monetary policy.

    Mr. BENTSEN. But then puts that in the possibility of an interest rate trap itself?

    Mr. MEYER. No, I don't believe that would be a problem at all.

    Mr. BENTSEN. Thank you, Mr. Chairman.

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    Chairman BACHUS. Thank you, Mr. Bentsen.

    Ms. Hart.

    Ms. HART. Thank you, Mr. Chairman.

    I have one question, and actually either of you might be able to shed some light on it. Some concern, a lot of concern has been raised by some of the larger institutions in the communities I represent regarding problems that could be caused to some of the small community banks as a result that if they are permitted to offer interest on their business checking that even though it isn't required, they will all feel a need to do it and may basically lead us into some other kind of banking disaster. I would just like to have either one or both of you shed any light on whether there is any merit to that at all?

    Mr. MEYER. I want to make sure I got your question correctly. I believe you said that larger banks are worried that this will cause a problem for smaller banks. Is that what you said?

    Ms. HART. Larger banks and those who have other kinds of investment instruments, yes.

    Mr. MEYER. It is very kind of the larger banks to worry about the smaller banks. I think we all appreciate that. I think maybe we should hear from smaller bankers who you will hear from on the next panel, and I think they will tell you that they are probably better off looking after their own interest than the larger banks. It may be the case that larger banks want to preserve their competitive advantage from sweeps.
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    Ms. HART. I certainly understand that, but my question to you was because I, unfortunately, like a lot of us, lived through the Resolution Trust Corporations' activities and saw a lot of strange things happen in the banking industry in what, the late 1980s, I guess, and——

    Mr. MEYER. We have had a lot of experience with banks paying interest on transaction balances, NOW accounts, that has proved very successful. It has been a benefit for banks and for consumers. I think the main point here is that giving small banks the opportunity to pay interest on demand deposit is going to make them more competitive in the market for relatively inexpensive funding and strengthen their financial conditions and competitiveness in the financial system.

    Ms. HART. So you see it all around as a benefit to the complete market, it is not going to weaken any player in the market necessarily.

    Mr. MEYER. No. I think it does level the playing field. That does mean that some banks that had competitive advantages might find the current circumstance better, but you have to weigh that against that the benefits of leveling the playing field.

    Ms. HART. Absolutely.

    Mr. Hammond.

    Mr. HAMMOND. It is really hard to add to that. I think I agree completely with Governor Meyer. Today what you have is a competitive imbalance to some extent between small banks and some of the larger banks with more sophisticated product offerings. This does, in fact, bring things more into an equitable balance situation. Obviously, that means that someone has to give something up in order for someone else to be on a more equal footing.
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    Ms. HART. Well, the other issue is, I think, there are almost not in the same market at this point, and by doing this, we place all of the financial institutions in the same market. Do you see any danger caused, because really the different tiers of the market really will become one in a lot of ways?

    Mr. MEYER. No. Small banks compete with larger banks and they compete with non-banks, and we are just giving them a better opportunity to be a more effective competitor in that marketplace.

    Ms. HART. I was just playing devil's advocate, by the way. Thanks very much.

    Thank you, Mr. Chairman.

    Chairman BACHUS. Thank you, Ms. Hart.

    Mr. Watt.

    Mr. WATT. Thank you, Mr. Chairman.

    I was going to start off by fussing at you all for why we were limiting this to business accounts, and then I realized that you did it for individuals, or we did it for individuals before I came to Congress. I think I had forgotten about that, because I never have enough money in my account to qualify for any interest, but it does raise an interesting question, which is whether either the Fed or the Department of the Treasury or any of the other regulators are keeping any statistical information about how effective NOW accounts have been, and the extent of individual deposits that are actually drawing interest on or having interest paid on them. Do you all have any information about that?
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    Mr. MEYER. Yes. There are $240 billion of what we call NOW accounts, interest-bearing transaction accounts held by households.

    Mr. WATT. What percentage of total deposit is that of individuals?

    Mr. MEYER. That is relative to demand deposits, some of which are held by households also, but most of which are held by businesses, that are about $315 billion.

    Mr. WATT. So it is working pretty well then is your assessment?

    Mr. MEYER. Absolutely.

    Mr. WATT. OK.

    Mr. Hammond, I am wondering, since this is a new Treasury Department, this turnover, whether there is any likelihood that you all are going to reevaluate your position on the reserve, on the payment of interest, because it seems to me, I guess I am kind of like Mr. Toomey. It seems inconsistent with the philosophy that this is the Government's money rather than the individual banks, or even the depositor's money, and that somehow the Government is entitled to this money in this budget equation. I understand that we could use it and we could spend it, but it just—your argument seems just completely inconsistent with the arguments that I have heard in support of returning tax moneys to people. And the President's question, in his address to the joint session where he asked who the surplus belongs to, my response to that by the way, is, it doesn't belong to anybody until it materializes. But if you follow what he was saying, it doesn't belong to the Government, it belongs to the depositor or the taxpayer, or so the bottom line is, it is likely that you all are going to reevaluate your position that you have testified about today, or you don't see that happening?
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    Mr. HAMMOND. I think what is likely is that more, as more appointees come into the Treasury Department, people will look at legislation that is going through the process and make independent judgments at that point in time, and I think additionally, what we have to keep in mind with regard to the cost, if you will remember back, what I said is that we are concerned about where it falls into the priorities of the Administration today, vis-a-vis the surplus.

    Mr. WATT. If you put somebody else's money in the priorities sometimes.

    Mr. HAMMOND. Obviously the decisions and the positions that people have to take depend on, to the extent that this were an expenditure of $700 million over five years, then another expenditure of $700 million over five years would have to be removed from the budget, all things being equal. I think it is that tradeoff and that debate which is likely to continue throughout the budget process. So I think it is very likely that new appointees also come in and look at the issue and look at the pros and cons and go forward from there.

    Mr. WATT. So I guess your, the bottom line of what you are saying is if we move this bill, they are more likely to look at it quickly and may reevaluate what you are saying.

    Mr. HAMMOND. They will certainly have the opportunity to be focused on that as they come on board, yes.

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    Mr. WATT. OK. While they are in the process of doing that, would you also deliver them a message that I would like for them to take a look at, our Mr. Lucas' bill, H.R. 557, which seems to me to fit kind of in the same category of things where we could refund some of the BIF and SAIF overcapitalized accounts. So if they are reviewing, can you deliver a message to them that we would like for them to take a look at that one too.

    Mr. HAMMOND. I think deposit insurance reform will be certainly a very important issue to be debated going on this year, and I suspect they will be quite focused on that and other components of this.

    Mr. WATT. Thank you, Mr. Chairman.

    Chairman BACHUS. Thank you, Mr. Watt.

    Mrs. Kelly.

    Mrs. KELLY. Thank you, Mr. Chairman.

    Governor Meyer, I welcome you again. I think you probably are familiar with a conversation that I had with Chairman Greenspan when he was here on February 28th. I just want to reestablish for the record a couple of the points that were made in that conversation. As I understood him to say, the Fed wants these bills to be merged, and he wants them to go forward as one bill; is that correct?

    Mr. MEYER. The main objective is to get both parts passed. Whether they pass as one bill or two bills is of no consequence to us, but we would be delighted to have it in one bill.
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    Mrs. KELLY. Well, for efficiency sake, it is probably a good thing for them to come through together. The second thing is that the Fed supports my language that allows for the payment of interest on the reserves held at the Federal Reserve Bank, and the language that gives the Fed greater flexibility in setting the reserve requirements; is that correct?

    Mr. MEYER. That is correct, and just to make it clear, that bill, it is my understanding, is written so that it allows the payment of interest on all three kinds of deposits, that is, required reserves, contractual clearing balances, and excess reserves. So it has that flexibility and it gives us a lot of options.

    Mrs. KELLY. Yeah, that is exactly the way we viewed it.

    Mr. Hammond, you indicated in your testimony that the Treasury Department is reviewing the policy of paying the interest on reserves held at the Federal Reserve banks. I would kind of like to get a commitment that the Treasury and the Fed will work together with our staffs so that we can do this all properly, efficiently and as cleanly as possible while we can address any concerns that the Treasury may have, and I just wanted to say that for the record, and get your agreement that that is the case.

    Mr. HAMMOND. We would be delighted, as we always are, to work closely with you and the Federal Reserve on these provisions. I would include that certainly to the extent that we look at budget costs, however, that we also have to include in those deliberations the Office of Management and Budget, as they are the Administration's chief keeper of the budget priorities.
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    Mrs. KELLY. I am hopeful we will be able to resolve that issue though.

    Mr. Chairman, that is all I am going to say in the interest of speeding this up. I am going to yield back the balance of my time.

    Chairman BACHUS. Thank you, Mrs. Kelly.

    Mr. Rogers.

    Mr. ROGERS. Thank you, Mr. Chairman.

    I was just trying to determine here from some CBO estimates, and your calculations of that $600 to $700 million to your budget, that was a static calculation of costs, kind of in a parochial view. Have you looked, or has anyone looked at the increased revenue that would be received by the accumulation of assets by those individual businesses from interest earned, which they previously do not enjoy?

    Mr. HAMMOND. I am not sure if I understand your question correctly.

    Mr. ROGERS. Well, the Federal Treasury will gain more money on the taxes paid by corporations on the increase of interest of which they don't enjoy now on those accounts; is that correct?
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    Mr. HAMMOND. Let me just back up and make sure I understand the question correctly. If I understand what you are asking, is the benefit that the business community will obtain from the payment of interest on reserves factored into the calculation of the net costs to the Government, and the answer to that is no, it is not. What the CBO and OMB projections are based on is an assumption on what it will be from a budget standpoint to Federal revenues and expenditures. So obviously, to the extent the overall economy benefits from moving some of that money out of the Federal coffers into the commercial banking system, that is another consideration.

    Mr. ROGERS. I am not sure we are on the same sheet of music.

    Mr. HAMMOND. OK.

    Mr. ROGERS. Just from what Congressman Toomey talked about, the administrative costs are obviously going to be less with the passage of this bill. Higher reserves that may net is going to be some increase to the Fed. But also, the Federal Treasury will gain in corporate taxation from gains in interest that small businesses don't currently pay, because they don't accumulate that asset. Am I correct?

    Mr. HAMMOND. You are correct.

    Mr. ROGERS. I have not seen anywhere in the calculations that I can find, so $600 to $700 million doesn't seem very real—it is a very static number.

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    Mr. HAMMOND. My understanding is those effects are actually factored into both the OMB and CBO calculations. We can verify that.

    Mr. MEYER. They use a 25 percent assumed tax rate, and that is explicitly in their calculation.

    Mr. ROGERS. That is a little different than what I am reading here from CBO. So maybe we can get all on the same sheet of music, and somehow some way maybe afterward, we can get—as a matter of fact, their last line, if I can quote from this, Mr. Chairman, if you will—''It is overall profits in Federal revenue, therefore it would not be affected.''

    Mr. MEYER. Are you talking about interest on reserves or interest on demand deposits? Interest on demand deposits would be a transfer from banks to businesses with no effect on tax revenue.

    Mr. ROGERS. Isn't that a static calculation? I am doing this for my own edification here. I am not trying to be confrontational.

    Mr. MEYER. It is very difficult to make an estimate of what the broader impacts of this would be on overall economic activity. What you are looking for is dynamic scoring, asking what other changes might occur in the economy and how that might generate additional income and tax revenue. That is a very difficult task to undertake. CBO did not make that calculation, and is not routinely made when estimating the cost of various programs.

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    Mr. ROGERS. I understand that. I guess my conclusion, or we will go back and do some of these as well, is if you can calculate the loss based on money for interest held in those accounts, you can also tabulate increased interest that previously was not taxed, and will be taxed just on those very simple calculations. We will play around with the numbers. I will be happy to talk with you.

    Mr. HAMMOND. We will be happy to work with you.

    Mr. ROGERS. I think that $600 to $700 million is way overstated when you talk about total revenue generated. There is an old saying that money is neither created or destroyed. I have a feeling taxation falls in the same category here and we will find the way to get that money somehow.

    Thank you, Mr. Chairman. I would yield back.

    Chairman BACHUS. Thank you. I will like to have the record reflect there is only a teddy bear remaining on the Minority side. And if it has no questions, we will go to Mr. Tiberi.

    Mr. TIBERI. I have no questions, Mr. Chairman.

    Chairman BACHUS. Thank you.

    Mrs. Capito, no questions.

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    Dr. Weldon.

    Dr. WELDON. I just have one quick question.

    Governor, you mentioned a lot of the machinations banks go through to keep their level of sterile deposits small with the Federal Reserve. You mentioned sweep accounts as one of them. What are some of the other things that they do?

    Mr. MEYER. Well, that is the major way that they reduce their required reserves. They take the deposits that are in the accounts that are reservable, and they find ways to transfer them into nonreservable accounts, preserving nevertheless the transactions' capability of the deposit holders, and that is what sweep accounts are all about. This is the major mechanism.

    Dr. WELDON. OK. I don't think I have any other questions. Thank you, Mr. Chairman. Thank you for your testimony.

    Chairman BACHUS. Thank you.

    Governor Meyer and Secretary Hammond, if we were to offer a bill that required interest payments on required reserves and not on clearing balances or excess reserves, what would your reaction to that be?

    Mr. MEYER. Disappointment. We understand that there is an issue about paying interest on required reserves. There is budgetary cost, and you have a decision that has to be made about how to finance that or what to offset it with. But in the case of contractual clearing balances, that is really a switch from implicit to explicit interest. There is no budgetary cost, and I can't see any reason why you wouldn't do that. With respect to interest on excess reserves, it is something we don't really contemplate using today, and that would only be in our tool kit. Should we be in a position where we would want to change the way we implement monetary policy, it would be useful to have. But it is something for the future, not something we would plan to implement over any near term.
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    Chairman BACHUS. Thank you.

    Mr. HAMMOND. Yeah, I think what you would be doing is miss ing a large number of the benefits that could be obtained from paying interest on a broader universe of reserves.

    Mr. MEYER. Could I make one other point? We have suggested here that if we don't get interest on required reserves, we would be very anxious, nevertheless, to have a bill that gave us the opportunity to have interest on contractual clearing balances. That would help. And if we had both together, it might be possible over time to lower reserve requirements by having more funds flow into contractual clearing balances with explicit interest. It might allow us the opportunity to lower the actual required reserve ratio. So there is a real advantage, it seems to me, in a bill that has both interest on required reserves and interest on contractual clearing balance. And I would certainly hope you would support that.

    Chairman BACHUS. I might ask both the first and second panel and the memberships they represent to look at the Kelly legislation, and you might suggest any changes in that as a result of that question.

    We have heard questions, and I think Ms. Hart was the one Member who asked some questions about maybe this is not in the best interest of the small banks, and I think maybe she recognized that there are small banks who oppose this, and I think we will probably, from the second panel, hear that some of their membership is divided, and at the same time in the past few years, organizations representing some of these same banks have asked the Congress to allow them to pay interest on business accounts.
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    Having said that, there is a tangible cost to the banks of having to pay interest which they can pretty easily calculate, I would think. On the other hand, it is rather intangible on how much, how many deposits they are losing from not being able to offer that. Do you know of any estimates as to the costs thereof? We know that the deposit base on the smaller banks which don't offer sweep accounts, that base has been eroding somewhat, but do you have any thoughts on that?

    Mr. MEYER. No, I don't have any numbers to share with you, but it is certainly true that when community bankers come in and talk about their issues, funding issues are at the very top, and their ability to compete for what they call core deposits. These transaction accounts are very important to them, and of course, paying interest on demand deposits is one way for permitting them to be more competitive for those deposits.

    Mr. HAMMOND. We are not aware of any estimates as well as to how you would, what the effect would be or what the deposit loss would be, or has been, to small financial institutions.

    Chairman BACHUS. Thank you.

    Do any other Members have a follow-up question? Oh, Mr. Weldon have you, you have been—all right.

    At this time, we will dismiss the first panel. I will say that the Chair notes that some Members may have additional questions for this panel which they may wish to submit in writing, and without objection the hearing record will remain open for 30 days for Members to submit written questions to these witnesses and to place those responses in the record.
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    At this time the first panel is discharged and I would like the members of the second panel to be seated, and thank you for your testimony.

    I would like to introduce the second panel at this time. From my left to right, Mr. James E. Smith is Chairman and Chief Executive Officer of Citizens Union State Bank and Trust in Clinton, Missouri, and President-elect of the American Bankers Association. We appreciate your testimony, Mr. Smith.

    Mr. David Bochnowski is Chairman and Chief Executive Officer of Peoples Bank of Munster, Indiana; Chairman of America's Community Bankers, and we appreciate your testimony and note, we also thank you for your service in Vietnam.

    And Mr. Thomas Jennings is Senior Vice President and General Counsel for First Virginia Banks on behalf of the Financial Services Roundtable based in Falls Church, Virginia.

    Mr. JENNINGS. Yes, sir.

    Chairman BACHUS. And Mr. Robert Gulledge, President and Chief Executive Officer of Citizens Bank of Robertsdale, Alabama, who is here representing as Chairman of the Independent Community Bankers of America. And if any of you have never been to Baldwin County, Alabama, it is your loss. Mr. Gulledge, a beautiful, beautiful county.

    At this time, without objection, your written statements will also be made a part of the record. You will be recognized for five minutes to summarize your testimony, and we will start with you, Mr. Smith, and Mr. Bochnowski, I have allowed you an additional minute because you have extensive submitted testimony.
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    Mr. BOCHNOWSKI. Thank you, Mr. Chairman.


    Mr. SMITH. Mr. Chairman, I would like to thank you for holding this important hearing. I would also like to acknowledge the continuing leadership of Representative Kelly on these issues, including sponsoring legislation to provide for 24 transaction sweep accounts, Federal Reserve flexibility on setting reserve requirements, and payment of interest on sterile reserves. We applaud her efforts and those of many Members of the subcommittee who helped move similar legislation through the House last year.

    We strongly support the legislative initiative underway in Congress that would authorize a new 24-hour transaction deposit account and allow the Federal Reserve to pay interest on bank reserve balances. I will briefly touch on each of these important issues.

    The banking industry has wrestled with the issue of paying interest on demand deposits for more than a decade. So far there is no consensus. However, there is broad industry support for creating a new account that will allow 24 transfers per month between a checking account and an interest-bearing account, that is one transfer for each business day. This is the concept contained in Representative Kelly's bill, H.R. 974, which we support. This new account will help banks meet the needs of their large and small business customers and better compete with non-bank firms, such as investment companies, security companies and credit unions that offer interest-bearing business accounts. Some bills introduced over the last few years go beyond ABA's current position in that they will eliminate the prohibition on paying interest on demand deposits. If Congress does decide to take such action, it is critical that an adequate transition period be provided. Banks often provide a bundle of services to compensate for the prohibition on paying interest such as transaction services, lending and lines of credit, and other ancillary services. A transition would allow time to unwind these arrangements and to price explicitly these services or reset any previously agreed-upon terms.
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    My second point relates to interest on reserves held at the Fed. ABA supports authorizing the Fed to pay interest on sterile reserves. The opportunity cost of holding non-interest-bearing reserves at the Fed has been significant over the years. Conservatively, we estimate the cost at $400 million this year. However, the cost to our communities are many multiples of this due to the additional foregone lending opportunities that would certainly arise. The high cost of sterile reserves naturally creates an incentive for banks to minimize this burden. The introduction of sweep accounts was one avenue to lower these costs. As a consequence, since late 1993, reserve balances at the Federal Reserve bank have dropped from almost $30 billion to $6 1/2 billion today. Simply put, required reserves held at Federal Reserve banks will continue to decline unless market interest rates are paid on these funds.

    Paying interest on reserves could help the Federal Reserve conduct monetary policy since it will allow the Fed to maintain reserves at whatever level it thought appropriate to achieve its goals. In addition, paying interest on reserves will facilitate the development of transaction deposit products and level the playing field between banks and other financial institutions.

    Finally, let me address the budget issue that surrounds this bill. Some argue that paying interest would have a negative budget impact, but the ABA believes that without the payment of interest, reserves will vanish and so will the Federal revenues received. However, if interest is paid, the declining reserve will be stemmed and Federal revenues will increase from what they would have been. Simply put, the payment of interest will yield a budgetary gain over time.

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    And in conclusion, the ABA strongly supports legislation that would authorize a new 24 transaction deposit account, and allow the Federal Reserve to pay interest on bank reserve balances.

    Thank you, Mr. Chairman, for this opportunity to appear before your subcommittee today.

    [The prepared statement of James E. Smith can be found on page 60 in the appendix.]

    Chairman BACHUS. Thank you.

    Mr. Bochnowski.


    Mr. BOCHNOWSKI. Thank you, Mr. Chairman. My name is David Bochnowski, and I am Chairman and Chief Executive Officer of Peoples Bank in Munster, Indiana. I am testifying today in my capacity as Chairman of America's Community Bankers on behalf of ACB. Thank you for this opportunity to testify on this issue of critical importance to community banks in small- and medium-sized businesses across America.

    ACB strongly supports allowing banks the option of paying interest on business checking accounts as reflected in the legislation introduced today by Representatives Toomey and Kanjorski. We also strongly support authorizing the Federal Reserve to pay interest on sterile reserves, in fact, these issues were first brought to the attention of Congress by ACB in 1994, and they continue to be a top priority of ours.
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    The ban on interest-bearing checking accounts is the last statutory vestige of Regulation Q, a Depression-era law that, in the words of Federal bank regulators, no longer serves a public purpose. Instead, this prohibition has resulted in an anti-competitive business environment that has allowed a limited number of financial conglomerates to corner the market for cash management services that continues to block off an entire area of potential deposits for community banks to lend to our neighbors and to our communities, and it prevents many small businesses from earning interest on their checking accounts.

    The obvious solution to these problems is for Congress to pass legislation allowing banks the option of paying interest on business checking accounts, and in fact, just last year, the House passed such legislation not once, but twice. Both bills were passed with the support of ACB and the National Federation of Independent Business, the United States Chamber of Commerce, and a host of other organizations. During a speech before ACB last December, Chairman Greenspan singled out the detrimental effects of this prohibition saying, and I quote: ''This is of particular concern to community bankers, of course, given that larger banks are offering interest to their customers through sweep accounts. Bending legislation, modernizing the law would potentially help bolster deposit growth and open opportunities for other profitable customer relationships without the unproductive and costly circumvention of the existing statute.''

    We are pleased Governor Meyer has echoed those remarks earlier in his testimony today. Given this broad coalition of support for repealing the ban, you may ask why this prohibition still stands. Historically, much of the opposition has been generated by a few large financial firms and banks. Unlike most community banks, these institutions can conduct sweep arrangements efficiently because they have the financial resources to do so.
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    As the head of a $400 million community bank, I can tell you firsthand that for most of us, sweep arrangements are a costly and cumbersome product. We offer them because we don't have the option of paying interest on business checking accounts. And for many smaller community banks sweeps are not an option. The minimum investment for these types of arrangements is well beyond the reach of most small- and medium-sized businesses.

    Mr. Chairman, we understand that large banks and Wall Street financial firms have invested significant resources in offering sweep account services to their customers. We do not begrudge the benefits they have reaped from their efforts, nor do we oppose their continuing to conduct business in this manner. But we do not believe it is asking too much to ask Congress to allow community banks, many of us who are strapped for deposits, to compete in the marketplace for cash management services.

    And what about small business customers that larger financial institutions do not serve? Doesn't it make sense for Congress to give them the option of earning a market rate of return on their deposits?

    We think the time has come to lift this artificial prohibition and keep more money on Main Street and off Wall Street. We are also well aware that some of our community banking brethren do not see eye to eye with us on this issue. Let me say to them that we do not support legislation that will require banks to pay interest on business checking accounts. We simply want the option for them to do so.

    Mr. Chairman, I would like to also express ACB's support for legislation authorizing the Federal Reserve Board to pay interest on sterile reserves held at Federal Reserve Banks. On behalf of ACB I would like to commend Representative Kelly for her ongoing efforts on this issue.
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    Finally, there is the critical point of timing with respect to this issue. Because a delay would only postpone the benefits of this much needed change, it is our strong preference that legislation giving banks the option to pay interest on business checking accounts do so immediately upon enactment. We do recognize that some institutions are seeking an extensive transition period. While we appreciate the efforts made by Representatives Toomey and Kanjorski to accommodate these concerns, we strongly believe a phase-in period is unnecessary and undesirable.

    ACB strongly endorses the Toomey-Kanjorski bill as an important step in allowing banks to offer interest-bearing checking accounts. We commend House Financial Services Committee Chairman Oxley for putting this issue on the fast track, and we commend you, Chairman Bachus, for holding today's hearing. Thank you again for the opportunity to testify before the subcommittee, and I look forward to any questions you might have.

    [The prepared statement of David A. Bochnowski can be found on page 69 in the appendix.]

    Chairman BACHUS. That was a 5-minute statement.

    Mr. BOCHNOWSKI. Thank you, Mr. Chairman.

    Chairman BACHUS. Mr. Jennings.

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    Mr. JENNINGS. Thank you, Mr. Chairman. I am the General Counsel of First Virginia Banks, Inc., in Falls Church, Virginia. I am pleased to have the opportunity today to speak on behalf of the Financial Services Roundtable. First Virginia is the oldest bank holding company in Virginia, with roots beginning in 1949. The Financial Services Roundtable represents 100 of the largest integrated financial services companies providing banking, insurance and investment products and services to American consumers. Roundtable member companies account directly for $17 trillion in managed assets and $6.6 trillion in assets and provide jobs for 1.6 million employees.

    Chairman Bachus, thank you for holding this hearing today and for inviting the Roundtable to participate. The Roundtable also extends thanks to Congresswoman Sue Kelly for introducing H.R. 974, which will be the focus of my testimony.

    The Roundtable strongly supports this bill and it would help to remove the hidden tax imposed on banks by allowing the payment of interest on banks' required reserves.

    The Roundtable strongly believes that any bill that allows institutions to pay interest on commercial checking accounts, such as the bill introduced by Congressman Pat Toomey, must be coupled with provisions allowing the Federal Reserve Board to pay interest on required reserves. The reason for this is simple. If institutions are to begin paying interest on commercial checking accounts, they will be forced to undertake significant changes in operating systems and, more importantly, they will be pressured to revisit their pricing for numerous account relationships.

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    Non-interest bearing, or sterile reserves held at the Federal Reserve, amount to a hidden tax on banks. This nonproductive use of deposits runs counter to the interests of all of our key constituencies, including our bank's management, shareholders and, more importantly, our customers and our communities. Reserve requirements make banks less likely to develop new and innovative deposit products since the cost of these products are artificially high.

    Let me explain how the bill which will permit the payment of interest on business checking will affect First Virginia. Currently our family of banks meets all of its reserve requirements through vault cash, the money we keep in branches and at other facilities, and through required balances held at the Federal Reserve. First Virginia has a program in place to aggressively manage the cash we hold and where we hold it in order to ensure that our customers receive cash when they need it. Because banks our size must hold 10 cents in reserve for every additional dollar held in checking accounts, allowing the payment of interest on business checking accounts would increase the amounts held in those accounts, thus substantially increasing our reserve requirements. The corresponding increase and required reserves may force us to hold excess cash over and above the amount we need to pay our customers. If First Virginia were to carry this money without receiving interest on it or without being able to put it to productive use, it could increase the hidden cost paid by our institution. If the Federal Reserve were to pay First Virginia and other banks interest on the reserves kept with them, the cost of holding these excess reserves would at least be partially offset.

    I would also like to point out a possible unintended consequence if a policy change results in banks holding additional non-interest-bearing reserves. Because an increase in these reserves would make it more expensive to banks to offer checking accounts, many consumers might choose to place their money in accounts outside the banking system. The end result might be that the Federal Reserve would hold even fewer reserves, because banks would be holding fewer deposits.
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    In the past, Congress has linked the issue of paying interest on required reserves with paying interest on commercial checking. In 1998, the House Banking Committee included both provisions as part of its broader regulatory relief package, as championed by Congresswoman Roukema. That bill, H.R. 4364, passed the House by voice vote.

    As the subcommittee has already heard, strong monetary policy arguments exist for allowing the Federal Reserve to pay interest on required reserves.

    Mr. Chairman, in conclusion, the Roundtable appreciates the opportunity to provide our comments and supports this important legislation that would remove the hidden tax on banks and urges Congress to follow its historical practice of combining payment of interest on reserves legislation with interest on commercial checking legislation. Thank you again for the opportunity, and I would be pleased to answer any questions.

    [The prepared statement of Thomas P. Jennings can be found on page 75 in the appendix.]

    Chairman BACHUS. Thank you, Mr. Jennings.

    Mr. Gulledge.

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    Mr. GULLEDGE. Good afternoon, Chairman Bachus, Ranking Member Waters and Members of the subcommittee. My name is Robert I. Gulledge and I am Chairman, President and CEO of Citizens Bank, a community bank of $82 million in assets located in Robertsdale, Alabama. I also serve as Chairman of the Independent Community Bankers of America, on whose behalf I appear before you today.

    I want to thank you for giving me the opportunity to testify and I want to congratulate you, Chairman Bachus, on your elevation to the Chair of this important Financial Institutions Subcommittee of the Financial Services Committee.

    I will first address the issue of paying interest on business checking accounts. Mr. Chairman, as you know, repealing the ban on paying interest on business checking accounts has been hotly debated among community banks for many years. Community bankers continue to be sharply divided on this issue. Proponents of lifting the ban argue that it would increase economic efficiency, simplify business practices and help them keep their best business customers. Opponents argue that lifting the ban would squeeze their margins and impose a financial burden on them that could jeopardize their ability to compete for business customers in their markets.

    In my written testimony I describe the impact this proposal would have on two different banks, one in favor of lifting the ban and one opposed. The banker who opposes lifting the ban from a $721 million assets bank on the East Coast calculated that he would have to raise more than $21 million in additional deposits just to offset the interest costs if he were forced to pay interest on his business checking accounts. This cost, he said, would be prohibitive.
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    The banker who supports lifting the ban from a $161 million asset bank in the Midwest feels that the current prohibition has been competitively damaging to his bank and to others. He argues that brokerage firms and other non-bank competitors have moved aggressively to compete with commercial banks for small business relationships, and without the tools to compete, banks and others could lose some of their best commercial accounts.

    Mr. Chairman, because bankers are split on this issue and the feelings run strong on both sides, the ICBA has advocated a compromise, that bankers on both sides tell us they can support. Under this compromise the number of allowable transactions from money market deposit accounts would be increased to 24 per month from the current legal limit of 6 while keeping the permanent prohibition in place. This alternative was proposed in legislation introduced by Representative Kelly last year. It would allow banks to sweep funds between non-interest-bearing commercial checking accounts and interest-bearing money market deposit accounts on a daily basis. Thus, banks would not be forced to offer interest on commercial checking accounts but, rather, would have the option of paying interest on their commercial checking accounts by using sweep mechanisms.

    Mr. Chairman, this is the only alternative that we are aware of that has not raised objections from one side of the issue or the other side of the issue. We urge you and the subcommittee to give this proposal serious consideration, and we stand ready to work with you on this compromise. If you determine to go forward with removing the ban, may I suggest you allow an appropriate time to dismantle existing contractual arrangements of existing accounts with our customers.

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    Let me now turn to the issue of allowing the Federal Reserve to pay interest on sterile reserves. We have no objection to this proposal, even though it is not an issue that would affect most small banks directly. Most small banks have transaction deposits in the lower tranche and are either not required to maintain reserves or can meet their reserve requirements with vault cash. In my written testimony I describe in greater detail the effect that this proposal would have on a typical ICBA community bank.

    Thank you for the opportunity to testify. I would be happy to answer questions you or the subcommittee may have. Thank you very much.

    [The prepared statement of Robert I. Gulledge can be found on page 80 in the appendix.]

    Chairman BACHUS. Thank you, Mr. Gulledge.

    At this time we will recognize Mr. Cantor for 5 minutes.

    Mr. CANTOR. Thank you, Mr. Chairman. And I guess any of panelists could probably answer my question. It is really for my own knowledge in trying to understand sort of the costs associated with the sweep accounts arrangements, and I hear some of you advocating a long transition period so you can unwind and get rid of the costs associated with them. Is there any other reason for these sweep arrangements other than to, if you will, get around the prohibition on interest checking for demand deposits for business?

    Mr. BOCHNOWSKI. Congressman, we introduced the sweep accounts this past August. We now have $10 million worth of deposits, if you want to call them that, that have been attracted to these accounts. Of that $10 million, only 6.5 percent comes from inside the bank. We have existing arrangements with some of our customers; therefore, they are not eligible for these accounts. So while we do not have the option of doing what we would like to do with business checking, we have still figured out a way to do it, and it is costly. The requirements that we have to come back to our customers with, which is to, on a daily basis, monitor the level of these repurchase agreements of Government securities and to inform our customers daily of the value of those Government securities. So there is tremendous cost involved. So, from our point of view, we would rather go ahead and let this option run to all banks and let each bank on its own in the free market decide how it wants to offer those products to their customers.
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    Mr. SMITH. I want to give you an experience in my bank. A little over a year ago, we succumbed to the sweep accounts and started offering the sweep accounts. I would tell you that today we have picked up about 4 percent additional deposits if I was able to keep those deposits in the bank. Those are outside deposits. But I do have the third party provider that takes care of the sweep operation for me and I am under a contractual arrangement to continue with that for a period of time. So at my particular bank, I would need some time to unwind from that contractual relationship.

    Also, for a number of my commercial accounts it has been years building up, what we call bundled services, whether it is below market interest rates on loans or purchasing their checks or offering them other incentives because we cannot pay interest on their corporate account. That is going to take some time to go back and work with those accounts and work out those arrangements so we can make it an equitable situation both for the corporate customer and for the bank.

    Mr. JENNINGS. Not only are there costs involved in the sweeps, but we found that our business customers sometimes have a hard time keeping up with what is going on and the smaller business customers especially have had problems maintaining enough staff to look at what we are giving them in the way of what we have done for them. So there are not only costs to us, but costs to our customers if they are doing that.

    Mr. GULLEDGE. I do not have sweep accounts in my bank, and obviously if this legislation—if this ban is removed, this is a service that I will have to provide to be able to be competitive and to provide the service. I am a practicing banker and I am going to provide the services that are demanded of my customers. But there are also contractual arrangements out there dealing with loan customers, conditional loan approvals, compensating balances, there is a lot of other things that are out there that would have to be dealt with, and it is not something that I think can be made effective immediately without having serious effect on the operations and the performance of banks.
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    Mr. CANTOR. Mr. Chairman, I yield back the balance of my time. Thank you.

    Chairman BACHUS. Thank you, Mr. Cantor.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman.

    There is some disagreement it appears among the panel over the timing of how quickly sweep accounts or how quickly an interest on deposit should be allowed, whether there should be a one-year transition or a two or three-year transition period. And I guess, Mr. Smith, I just heard you—I kept getting paged, so I apologize I had to keep getting up—but I heard you say you have a contractual—in your own instance, you have contractual arrangements with a provider that requires you to work with them for a certain amount of time. I guess my question is do any of you all know what the average length of the sweep arrangement contracts are? It would seem to me that a lot of these are a year or less and would be fairly flexible to get out of. Maybe that is not the case.

    Second of all, Mr. Gulledge, I wonder with respect to your members in particular, I understand there are some members who would not, smaller banks where it would be cost prohibitive to establish perhaps your own system of setting up interest payments, whether you were going to hedge or what not. But there is a ready market already there offering money market demand accounts. The banks are using them as it is. Why wouldn't your banks want to use that at a nominal fee for the benefit of their customers?
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    Mr. GULLEDGE. Well, in the written testimony I have given you the example, as I alluded to, of the two banks, one that was a $721 million bank that said he would have to develop a $21 million deposit growth to compensate for the cost and yet another at $161 says that he needs it to be more competitive. And I think what we are really saying here is that every community bank is going to have to look at their market, they are going to have to look at their competition, they are going to have to take a look at their customer base. There is a lot of work, and here again this is another reason, in my opinion, for giving a period of time in working out the proper arrangement so that every bank can look at it and make their own decisions as to what can be profitable.

    Mr. SMITH. I don't know that there is any specific—I don't know the numbers—if there was any time that it would take, the average time to eliminate the sweep accounts, but please keep in mind it is not just the contractual relationships on the sweep accounts. Maybe I've quoted a loan at a below market rate because of the compensating balances and that might be a five-year loan. So I have already committed to a loan customer on one side of the ledger and then I want to at least try to average it out so I can come out on the other side of this issue. So perhaps I purchase their checks. Some of these checks are expensive, maybe $4-$5,000 for a two-year supply of checks. So what we are trying to do is balance this so we can make this transition period as smooth as possible for the banks to work into this. And it is voluntary, so in some of these arrangements you may want to continue the way you have been for a period of time until you can handle it.

    Mr. BENTSEN. I don't completely understand what you are saying. Are you saying that in some of your arrangements that you have with your commercial clients that you have offset some of your cost or you have hedged some of the benefits you are providing with your customer with the rate you are getting through the sweep account? So it is not just a question of getting out of the sweep account, it is other costs that are factored into that as well?
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    Mr. SMITH. That is correct. It is a whole bundle of services that we have been trying to provide to our corporate customer in lieu of paying them interest on their checking accounts.

    Mr. BOCHNOWSKI. We all have these contractual arrangements, yet they don't have to hinder the small business side of this. I don't know that we should ask them to wait, especially since our experience has been that we do bring funds from outside the banking system into the banking system when we offer a product that is akin to this, the sweep accounts that we now have. The time that it would cost any of us to let our existing relationships run off: that is on our side, but there are many bankers who have not chosen to take the steps that we have. And we will ask them to wait until we can solve our problem in order for them to be able to offer this business checking option that we would like to have to their customers. And I think it is fair to say that we shouldn't ask the rest of the banking industry to wait while we catch up.

    Mr. BENTSEN. Mr. Chairman, I sort of agree with that viewpoint, but I guess obviously you make an arrangement with your clients and you put together a package that is both beneficial to your client or obviously they would not be there, and beneficial to the bank and stockholders, because you are ultimately in the business of making money, which is a good thing. But I think that Mr. Bochnowski is somewhat correct that—I mean, we can't stop the clock if we are going to try to continue to deregulate the banking industry, which is the next step to do that.

    Mr. SMITH. I would only say that this is voluntary so nobody has to wait. If they want to offer the 24 transfer, that is the same thing and so nobody has to wait. They can offer that product. And I may want to continue to offer my sweep products instead of offering the 24 transfer.
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    Mr. BENTSEN. But overall deregulation would be put off for two or three years on some of the bills that are being considered, and I think that is an issue that we have to think long and hard about.

    Thank you all.

    Thank you, Mr. Chairman.

    Chairman BACHUS. Thank you, Mr. Bentsen.

    Mr. Toomey.

    Mr. TOOMEY. Thank you, Mr. Chairman.

    I would just like to follow up on the issue of the voluntary nature of this, because I spent many years as a small business owner and I have had accounts with banks and I have run into all of these arrangements, or at least a number of arrangements that have been alluded to, whereby I have had a loan where the interest rate charged to me on the loan was contingent on a certain balance that I would not earn interest on. It strikes me if you got such a loan on the books you could leave it exactly as it is, because this bill would not require paying interest on those deposits; it would simply provide the option.

    Similarly, I remember going through stacks of my bank statements that were very complicated and very lengthy to total up all of the little credits against service charges that I was being given, again in sort of compensation for the average balance that I have left. And again, it seems to me that is something that could continue. I don't know why anyone would, but you could continue it. So I guess from the point of view of the corporate borrower or your customer in that sense, I am wondering if I am missing anything. Are there other kinds of transactions where, absent a long phase-in, you would really have a contractual problem, or could you not continue with the current arrangement as a practical matter with respect to most of your customers? Maybe not with your correspondent banking relationship whereby you have the sweep accounts, but with relationship to the customers. Am I missing categories of transactions or something?
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    Mr. SMITH. I can only give you the experience of my bank. It is a rural bank in mid-Missouri and most of my arrangements with compensating balances are implied arrangements. They are not written arrangements. And basically it is discussions and knowing my customers for the past 27 years that I have dealt with them. I just need some time to work with them, educate them that we are unbundling, listing this service. We are going to be paying interest on their account if they so desire, but at the same time we will be doing some other things on the other side of the ledger that may be charges to them. I don't have necessarily very many contractual relationships that say you have to keep a six figure balance in order to get this interest rate on your loan. It is more of an implied number, just from my knowledge and history of what this business has done in the past.

    Mr. TOOMEY. In your case, if you had one year for this change to take place, would that give you enough time?

    Mr. SMITH. I still have a contractual relationship with a third party vendor out there that is going to go two years, so I've got to take care of him. So obviously we have got to meet my contractual relationship.

    Mr. TOOMEY. OK. I had another question for Mr. Bochnowski and I was wondering if you could share for us, I expect a lot of Members are not familiar with what a repo is and the mechanics and costly nature of trying to create this transaction as the way to circumvent this archaic rule. I was wondering if you could share with us how and why it is really a pain in the neck.

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    Mr. BOCHNOWSKI. I appreciate that opportunity, Congressman. It is transparent to the customer, but on the bank side literally what we have to do is the customer's large deposit, instead of going into a checking account goes into a repurchase agreement; that is to say, they take a security interest in Treasury bills that we already own. And we are required by bank regulation when we do that—and since that is outside the depository relationship funds can sweep between their checking accounts and that account numerous times a day without violating any existing rule. But, because of the nature of the banking rules on this issue, we are required—first of all, we cannot pledge more than we have, so we have to monitor that security on a day-to-day basis, or those securities that are bundled on a day-to-day basis to be sure that we haven't exceeded regulatory requirements there. Second, because it is a repurchase agreement, again under requirement, we must tell the customer every day what the value of that security is. So we are forced to do a lot of bureaucratic transactions at a fairly substantial cost in order to reach a result to get around the law and to provide a transparent result to the customer.

    There is also a practical consideration here. At a bank our size, which is $400 million, we might have a securities portfolio on any given day of $40- to $50 million. Some of that is held for sale and some of that is our permanent portfolio. We can only attach this product to the permanent side of the portfolio. And so that we might be limited—there is a finite point at which we can no longer offer this service within our community because we run out of securities. If we have to wait for a year or two or three years, there again, I am going to say to my customers or people who have the potential to bring money back into the banking system, ''This is a great product, but could you wait ten or twelve months until I get back to you?'' I do not think that is necessarily good for our bank, I do not think it is good for our community, and I do not think it is good for our small business customers.
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    Mr. JENNINGS. Technically that is a sale of securities by the financial institutions to the customer with an obligation or a commitment to repurchase those securities at a certain interest rate. And as my colleague over here said, there is only a limited number of securities that banks hold in their portfolios. So these are Federal Government securities and there is a limit to how much that is, so you can't offer that to anybody.

    Mr. TOOMEY. And they have to be marked to market daily and it strikes me as a rather cumbersome process as opposed to paying 4 or 5 percent interest.

    Mr. SMITH. Correct.

    Mr. TOOMEY. Thank you. I yield back the balance of my time.

    Chairman BACHUS. Thank you.

    Ms. Hart, do you have any questions?

    Ms. HART. Thank you, Mr. Chairman.

    I did ask a question of the earlier panel that I don't think I need to ask again of this panel. Your testimony is all pretty clear. I think the one disagreement that I would like to get a little bit more of a handle on, or I guess some of you have been noncommittal, is the amount of time we ought to take, if any, to phase in the interest on business checking. The first panel clearly doesn't want any time to really be spent on a phase-in. I would just like each of you to comment on what you think would be the ideal amount of time for us to take until that is phased in, if it is phased in, or if we do it instantly.
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    Mr. SMITH. The bill that passed the House last year had a three-year phase-in and the American Bankers Association supported that bill, and that would be our position today.

    Mr. BOCHNOWSKI. America's Community Bankers would like to have it phased in immediately, because this is an option. We think that every bank could, at its own pace, decide when it wanted to phase it in and they could take that approach. I think the problem with the phase-in is you get the result, but you have a cumbersome process, because you have to go from money market accounts to the checking accounts. You have a double set of accounts you have to keep track of. You have a double set of regulations you have to watch. Why not just do it? If we are going to do it, let's do it.

    Mr. JENNINGS. Our members have incurred, a lot of them anyway, have incurred substantial costs in putting into place existing systems that they have. On the other hand, our members probably can afford to make the transition a lot easier than some of the other institutions could. So we did not take a position one way or the other on this, but we would not be opposed to whatever the subcommittee does up to a three-year phase-in.

    Mr. GULLEDGE. The differences that you are hearing between this panel and the other panel is that we are—for the most part, we are the practicing bankers and we are the ones that will be affected by the transition period, and I would say at that point as a minimum we need a three-year transition period.

    Mr. HART. Thank you for that. So there isn't complete agreement, and that is OK.
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    The other issue is the one that I had asked about earlier, was a question about pressure on the banks, and I think I want to direct this actually to community banks, because you are smaller to begin with, and the question that I had was is there any reservation in the back of your mind about the pressure that might be exerted upon your bank to compete in a market with a lot fewer resources and to offer interest even though it is not mandated by this law and even though your members or you may not feel that it is the wisest thing to do in order to stay even in business? Does that thought enter your mind or is that something you have heard from many of the members of the Association?

    Mr. SMITH. I could respond. With my bank, personally, as I said, I started sweep accounts about a year ago and I have about $6.3 million in those sweep accounts and that is money that was going outside the community from local businesses and corporations. It was going outside the community. And I am glad I started it because I found some funding that I would like to get back into the community. If we do the 24 transfer legislation, then that will give me the opportunity to handle some of the liquidity problems in my community, my bank.

    Mr. BOCHNOWSKI. Congresswoman, I don't see that as an issue. I think we are under pressure right now to compete in our marketplace for all kinds of deposits and all kinds of products and services. I started in this Roundtable community of banks back in 1976 and I think the Federal Reserve statistics are that, at that point 90 percent of all deposits, all domestic deposits were at passbook or less in the United States of America. Times have changed. Clearly regulators also look at something called interest rate risk. They have to watch us very carefully at the behest of Congress on those kinds of issues. I think that the industry has proven that it can deal with these issues. And I think that we—Jim's company is currently offering this product. We are, too. I think we are doing it prudently. I don't think we are giving away the store at all.
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    Mr. JENNINGS. The 24 sweep issue is—obviously our preference is to have interest on checking and interest on sterile reserves linked together. That is preferable. I can remember back to 1978 when the interest was allowed first to be paid on consumer checking accounts and it did not start out as interest on checking accounts. It started out as interest on savings accounts, which you could sweep into checking to pay the checks that came in, and only after a period of time did we go to NOW accounts and allowing interest on NOW accounts. In my own view, that is just people realize that is what the market is and that is the way things ought to be. So the 24 sweeps, I think if we went that route it is just temporary and eventually we would go to the market rule, which is paying interest on the funds that you have that belong to somebody else.

    Chairman BACHUS. Thank you, Mr. Jennings.

    Mrs. Kelly.

    Ms. Hart.

    Ms. HART. Mr. Chairman, I just realized that my time was up. Thank you.

    Chairman BACHUS. Thank you.

    Mrs. Kelly.

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    Mrs. KELLY. Thank you, Mr. Chairman.

    Mr. Smith, can you tell me the percent of accounts that are business checking accounts at your bank?

    Mr. SMITH. Probably 35 percent business checking accounts, and I have some accounts classifieded as ag loans or ag accounts that would be approximately another 3 or 4 percent, because they are incorporated. So somewhere between 35 and 40 percent.

    Mrs. KELLY. Thank you.

    Mr. Bochnowski, can you tell me what percent of accounts you have in your business checking accounts in your bank?

    Mr. BOCHNOWSKI. It fluctuates, but I would estimate it is 20 to 25 percent.

    Mrs. KELLY. That is considerably less than Mr. Smith holds in his bank. So would I be wrong in assuming that you see the repeal of the prohibition of paying interest on business checking as a way that you can attract a greater number of business deposits in your bank?

    Mr. BOCHNOWSKI. I think that has something to do with it. I think there is also a little bit of history. While we are currently chartered as a State bank under Indiana law, we started as a thrift. Our company is 90 years old. We haven't been able to have business checking accounts for—except for the last probably decade—ten or fifteen years.
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    Mrs. KELLY. Mr. Bochnowski, your testimony did not address the issue of giving the Fed greater flexibility in setting the reserve requirements. Do you have a position on my legislation there?

    Mr. BOCHNOWSKI. We are in favor of your legislation there.

    Mrs. KELLY. Thank you. Also in your testimony you said that sweep activities are a costly and cumbersome product. I find this a little bit confusing, because I have a copy of a report in my hand here, it is Service and Product Solutions for Community Banks, which it says on the masthead, ''Brought to you by America's Community Bankers.'' And on page six of this ACB publication it says—and I can read it or you can see it, and I have done my homework here, and underscored it: ''The banks utilizing sweeps are finding that they are strengthening existing customer relationships as well as benefiting from obtaining new bank clients. A bank sweep account in a focused marketing plan represents a serious advantage in expanding and acquiring new business relationships, which can be extended into other banking opportunities.''

    It just seems very interesting to me that you would give such different testimony from what the ACB writes in its own publication.

    Mr. BOCHNOWSKI. I don't disagree with what is said there. When I say they are costly, I mean it in this sense, Congresswoman. The threshold for our sweep accounts is $50,000. We cannot start our business customer until they get to that level. We would like to have it be much lower. We would like to see it at the $10- or $15,000 level, depending on their relationship with the bank in other ways, as has been alluded to in this testimony. But I think when I say they are costly, it is simply because they are, and that we cannot start the process of entering the customers into the sweep accounts until they can reach a certain deposit threshold level.
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    Mrs. KELLY. Thank you very much. I yield back the balance of my time.

    Chairman BACHUS. Thank you.

    Mr. Rogers.

    Mr. ROGERS. Thank you, Mr. Chairman.

    Mr. Smith, you mentioned a point earlier that caught my attention. You said that—and maybe I misunderstood you—if we move the date up it would cause some liquidity problems for the bank. I assume that is because of the contractual relationship you have with your large corporate accounts. Can you help me understand that?

    Mr. SMITH. No, I don't believe that is the way I intended that to sound. I think if we moved the date forward I think it will be difficult for the banks that are under contractual relationships to unhook from those relationships and unbundle those services quickly. And I think it will cost them some money on the bottom line in trying to meet that timeframe and move into the other timeframe. I didn't mean it from a liquidity standpoint, from a lending framework. I just meant that it would cost some of those banks some money on the bottom line in order to unbundling this program and starting a new program at the same time.

    Mr. ROGERS. Can you give me an example of some kinds of activity you would want to unbundle and leave off the table in lieu of paying interest?
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    Mr. SMITH. For instance, I will go back, if we have purchased checks for this corporation, if we were going to pay interest on their checking account in the future we would not be interested in purchasing their checks and being out that expense. If we were going to tie it to compensating balancing, their loan rates—if we are going to tie that to compensating balances, then we won't be as interested in giving them such an advantageous program, if we are going to be paying them out on the other side of the ledger, because we have to balance the income and expense accordingly. So that is basically what I was driving at when I indicated we would have to unbundle some of these services and we would need time to get that accomplished as we move into this transition.

    Mr. ROGERS. I appreciate that. I relayed a story earlier to Congresswoman Kelly that I was in a very rural, very small town in Michigan yesterday, having a meeting completely separate from this issue, and the local community bank closed its doors and walked down in total to that meeting to tell me to support this particular issue. I want to congratulate Congresswoman Kelly. If this can have that kind of a profound impact on a community that needs all the help it can get, I will be with it.

    With that, Mr. Chairman, I yield back the balance of my time.

    Chairman BACHUS. Thank you.

    In addition to the witnesses that have testified before us today, the subcommittee has received written submissions from the United States Chamber of Commerce, the National Federation of Independent Business, the Association of Financial Professionals and the Community Bank Coalition, and their written submissions will become part of the record without objection.
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    [The information can be found on page 85 in the appendix.]

    Chairman BACHUS. And some Members may wish to submit to the panel, both the first and second panel, written questions, and with unanimous consent I am going to ask that the record be held open for 30 days to permit Members to submit those written questions to you and for you to respond back and allow them to introduce your responses into the record. So if they do make written requests of you, I hope that they will do so promptly and that you all will respond so that they may introduce those within 30 days. Obviously if they get them to you 3 weeks from today it may be tough.

    Mr. JENNINGS. I will be glad to answer any questions.

    Chairman BACHUS. Thank you.

    With that, we thank you for your testimony. The second panel is discharged, and the hearing is adjourned. Thank you.

    Mr. JENNINGS. Thank you, Mr. Chairman.

    [Whereupon, at 4:28 p.m., the hearing was adjourned.]


March 13, 2001
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