How will this change companies’ banking relationships?

Tucked within the hundreds of pages of the Dodd-Frank Wall Street Reform and Consumer Protection Act is Section 627, “INTEREST-BEARING TRANSACTION ACCOUNTS AUTHORIZED.” This section repeals what’s known as “Reg Q,” which prohibited banks from paying interest on demand deposits. One year from the passage of the bill, or July 21, 2011, banks will be able to pay interest on checking accounts.

Interestingly, Reg Q was enacted during the Depression in an attempt by the Federal Reserve to prompt banks to begin lending again. The thinking was that lowering banks’ costs by not requiring them to pay interest on reserves held with the Fed and prohibiting them from paying interest on checking accounts would stimulate lending, says Paul LaRock, principal with Treasury Strategies.

Today, the economy bears a resemblance – albeit muted – to the 1930s, and the action is the opposite. What gives? “The thinking now is that permitting banks to pay interest will in the long term permit them to attract capital which they’ll be able to lend out,” LaRock says. If they can lend, businesses can boost inventory, launch new products, and expand – hopefully adding employees as they do.

To be sure, banks have long figured out other ways of rewarding their better customers, even without the ability to pay interest. With their corporate clients, many banks offer earnings credit rate (ECR) or credits that can be used against the fees they charge.

Even so, this bill represents a significant change for banks. On average, business customers account for 8 percent, or $21 billion, of profits across the banking industry, according to Treasury Strategies. If competitive pressures force banks to pay interest, that will cut into those profits. On the other hand, banks that are looking to boost their business deposits now have another fairly simple and low-cost tool they can use to do so: By letting business customers know that they’ve bumped up the interest they’re paying, money should (at least in theory) move their way.

On the other side of the equation, corporate banking clients likely will view the ability to earn cold, hard cash on the funds they have stashed in their bank accounts as a positive. It may simplify cash management, especially for companies with many locations and sprawling networks of banks, LaRock says. Currently, treasurers with these firms often try to concentrate scattered deposits as quickly as possible in order to move them into an account that will earn interest. The ability to get some type of interest on a greater range of deposits should provide a bit of breathing room when it comes to consolidating accounts.

Still, banks that start paying interest will see their own expenses go up and may pass on those costs to clients by charging higher fees for other services. And, bank account management may become even more complex, as it’s likely that many banks will offer a range of pricing options that include both earnings credits and interest.

At this point, it’s hard to say how the move will impact corporate capital flows, let alone the impact it may have on bank lending and business borrowing. Moreover, by the time these new regulations take effect, the economy could look significantly different than it does today. However, the change should help to level the playing field between bank accounts and other investment options, which is a positive. ###