[Name deleted]

Dear [Name deleted]:

Thank you for your letter of February 20, 1997, regarding the Board's requirement that limits the number of withdrawals and transfers from savings accounts, and regarding the general level of interest rates. Your letter has been referred to me for a response.

The regulation which governs the savings account requirement is Regulation D. The restrictions on transfers from savings deposits in Regulation D are imposed by the Board to implement section 19 of the Federal Reserve Act. Section 19 among other things requires depository institutions to maintain reserves on transaction accounts at a rate of not less than eight percent or more than fourteen percent, as the Board shall prescribe. This requirement is used to implement monetary policy. Under Regulation�D, currently a depository institution must hold reserves equal to ten percent of its transaction deposits in excess of $49.3 million. By statute, a higher reserve requirement is imposed on transaction accounts than on savings accounts because of the greater ability of depositors to transfer funds from transaction accounts than from savings accounts. At present, savings deposits are subject to a zero percent reserve requirement. Reserves do not earn interest and therefore result in an opportunity cost to the institution that must hold them.

The statutory requirement for different reserve treatment of transaction accounts on the one hand, and savings accounts on the other, creates a need to distinguish between the two types of accounts based on the ease with which the depositor may transfer funds in the account to third parties. The more convenient it is to make withdrawals or transfers, the more the account becomes a transaction account as opposed to savings. In order to implement section 19, the Board of Governors of the Federal Reserve System has drawn the line at six convenient withdrawals or transfers per month by defining transaction accounts and various types of savings accounts in Regulation D. Section 204.2(d)(2) of the regulation defines a savings deposit to include:

A deposit or account . . . that otherwise meets the requirements of section 204.2(d)(1) and from which . . . the depositor is permitted or authorized to make no more than six transfers and withdrawals , or a combination of such transfers and withdrawals, per calendar month . . . by means of a preauthorized or automatic transfer, or telephonic (including data transmission) agreement, order or instruction.

12 CFR 204.2(d)(2).

The definition serves only to determine whether an account is a savings account or a transaction account, and there is no prohibition against accounts which permit withdrawals and transfers in excess of the specified limits. However, a depository institution must limit preauthorized transfers and telephonic instructions (including those transmitted from a home computer and those automated using a touch-tone telephone) from a deposit account in order to classify the deposit as a savings deposit. As it is generally more convenient to make a transfer at home than to go to a branch, withdrawals or transfers in person at a branch are unlimited. Withdrawals from an ATM machine, which involve more inconvenience than home banking, and transfers by mail or to repay loans from the institution (other than overdrafts), are also unlimited.

F&M Bank is thus limiting withdrawals and transfers in order to avoid having to classify the account as a transaction account and hold up to ten percent reserves against it. In addition to limited-transaction savings accounts, depository institutions generally offer an account like a NOW account which pays interest but does not limit withdrawals or transfers. Such an account in effect is an interest bearing account with unlimited withdrawal and transfer capability. As such, it is a transaction account subject to reserve requirements and may offer a lower interest rate than a savings account with limited transfer capabilities and no reserve requirement.

You also asked why interest rates have been kept at very low levels. Actually, most interest rates are not under the direct control of the Federal Reserve. Apart from the Federal Reserve�s discount rate (the rate at which it lends to depository institutions) and the federal funds rate (the interest rate on overnight interbank loans), most interest rates are determined through market conditions, including the supply and demand for funds. These conditions, in turn, are influenced by a variety of factors, such as savings propensities and the demand for capital in the economy. Particularly important in determining interest rates is the outlook for inflation. Savers and investors require higher rates of interest when they are concerned that inflation will erode their principal and interest relatively rapidly and lower rates of interest when they are less concerned about inflation. In recent years, as inflation has declined, this �inflation premium� in interest rates appears to have fallen, contributing to a decline in the nominal level of market interest rates, but �real� interest rates--the true return after subtracting the inflation premium--have declined to a much smaller degree.

The very short-term interest rates under the Federal Reserve�s control also influence market interest rates and those set by banking institutions. In coming to decisions on very short-term interest rates, the Federal Reserve is guided by the outlook for economic growth and inflation and its statutory objectives to promote maximum employment and price stability. In circumstances in which inflationary pressures are damped and growth is slack, the Federal Reserve would generally increase the provision of reserves to the banking system to bring short-term interest rates to relatively low levels. As you noted, this was the situation in the early 1990s. When economic growth and inflationary pressures pick up, an increase in interest rates may be appropriate. Indeed, in 1994 and 1995 the Federal Reserve raised the federal funds rate from 3 percent to 6 percent to restrain inflationary pressures. Those steps were successful, and as a consequence the rate was subsequently eased to 5-1/4 percent.

I hope this information is helpful. Please let me know if I can be of further assistance.

Very truly yours,

(signed) Oliver Ireland

Oliver Ireland