Regulation D Excessive Transaction Monitoring

Regulation D sets transaction limitations on savings accounts where a customer is not permitted to make more than 6 restricted transaction from the account during the statement cycle (or calendar month).  If a customer repeatedly makes excessive withdrawals, Regulation D, by definition, changes the account type from a savings account to a transaction account. The result is that a converted account would be incorrectly reported on the Call report by the financial institution.  Therefore, applicable banking regulations (i.e. Regulation D) require financial institutions to monitor and manage excessive restricted transactions and to take action if a consumer exceeds the maximum number of transactions permitted on a savings account.

Overview of Excessive Transaction Monitoring

To ensure compliance with Regulation D, financial institutions must monitor savings accounts to ensure that that the transaction activity in these accounts do not exceed the limitations directed by Regulation D for savings accounts.  The challenge that many community banks and credit unions face regarding this is that the regulation itself is fairly vague as to what is actually required in regards to monitoring these accounts.

To understand this rule, let’s take a deep dive into the rules.  Specifically, Regulation D defines a savings deposit in 204.2(d) as follows:

Savings deposit means a deposit or account with respect to which the depositor is not required by the deposit contract but may at any time be required by the depository institution to give written notice of an intended withdrawal not less than seven days before withdrawal is made, and that is not payable on a specified date or at the expiration of a specified time after the date of deposit. The term savings deposit includes a regular share account at a credit union and a regular account at a savings and loan association.

The term “savings deposit” also means: A deposit or account, such as an account commonly known as a passbook savings account, a statement savings account, or as a money market deposit account (MMDA), that otherwise meets the requirements of §204.2(d)(1) and from which, under the terms of the deposit contract or by practice of the depository institution, 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 or statement cycle (or similar period) of at least four weeks, to another account (including a transaction account) of the depositor at the same institution or to a third party by means of a preauthorized or automatic transfer, or telephonic (including data transmission) agreement, order or instruction, or by check, draft, debit card, or similar order made by the depositor and payable to third parties. A preauthorized transfer includes any arrangement by the depository institution to pay a third party from the account of a depositor upon written or oral instruction (including an order received through an automated clearing house (ACH)) or any arrangement by a depository institution to pay a third party from the account of the depositor at a predetermined time or on a fixed schedule. Such an account is not a transaction account by virtue of an arrangement that permits transfers for the purpose of repaying loans and associated expenses at the same depository institution (as originator or servicer) or that permits transfers of funds from this account to another account of the same depositor at the same institution or permits withdrawals (payments directly to the depositor) from the account when such transfers or withdrawals are made by mail, messenger, automated teller machine, or in person or when such withdrawals are made by telephone (via check mailed to the depositor) regardless of the number of such transfers or withdrawals.4

In the second part of this definition, Regulation D provides a footnote (#4) after the end of the section.  This footnote explains the requirements for financial institutions to monitor for excessive transactions on deposit accounts.  In fact, this footnote is the only guidance in Regulation D regarding excessive transaction monitoring. This footnote states the following:

4 In order to ensure that no more than the permitted number of withdrawals or transfers are made, for an account to come within the definition of “savings deposit,” a depository institution must either:

(a) Prevent withdrawals or transfers of funds from this account that are in excess of the limits established by paragraph (d)(2) of this section, or

(b) Adopt procedures to monitor those transfers on an ex post basis and contact customers who exceed the established limits on more than an occasional basis.

For customers who continue to violate those limits after they have been contacted by the depository institution, the depository institution must either close the account and place the funds in another account that the depositor is eligible to maintain, or take away the transfer and draft capacities of the account. An account that authorizes withdrawals or transfers in excess of the permitted number is a transaction account regardless of whether the authorized number of transactions is actually made. For accounts described in paragraph (d)(2) of this section, the institution at its option may use, on a consistent basis, either the date on the check, draft, or similar item, or the date the item is paid in applying the limits imposed by that section.

The challenge with this guidance is that the regulation doesn’t expand any further than the footnote regarding the expectations for excessive transaction monitoring.   Specifically, one challenge that remains from the vagueness of Regulation D is that the rule does not define what an “occasional basis” is, as referenced in the second option for a financial institution to “ensure that no more than the permitted number of withdrawals or transfers are made.”

The Federal Reserve on Regulation D Excessive Transaction Monitoring

In regards to monitoring for excessive transactions that exceed an “occasional basis,” the industry best practice has been to adopt a “three-strike rule” approach to monitoring.  This three-strike rule appears to stem from Board staff opinions and rulings provided by the Federal Reserve Board, which has also been republished in the OCC’s “Comptroller’s Handbook” on “Depository Services.”  The full handbook can be found here

When discussing the three-strike rule, one could assume that the rule worked like baseball: one strike you get warned, two strikes you get a final warning, and three strikes (in a rolling 12 month period) gets you kicked out of the account. While this is typically how most financial institutions utilize the three strike rule, this isn’t always the case as the guidance actually differentiates between 1) violations in consecutive months, 2) violations in non-consecutive months, and 3) significant violations within a single month.

First, the Federal Reserve appears to apply the three-strike rule as “three strikes and you’re out” when transaction limitations are violated in three consecutive months. Specifically, a different the (2/15/1990) Federal Reserve Board staff opinion states the following:

“Accounts exceeding the transfer limitations for three consecutive months should be converted to a transactions account.  The guidance states, if the depositor exceeded the transfer limit for a third consecutive month, the institution would send a letter informing the customer that the account has been converted to a transaction account.”

That said, a later part of this same guidance discusses situations in which violations occur in non-consecutive months. In these cases, the guidance appears to imply that the three strike rule is “four strikes and you’re out” as seen here:

“For this reason, the Board has applied a general rule that an institution may continue to consider an account an MMDA even if there are excess transfers so long as those excess transfers are not the result of an attempt to evade the transfer limits, and if the excess transfers occur in not more than three months during any 12-month period.”

As you can see, this portion of the guidance appears to apply a different approach to the three-strike rule when referencing violations that are not consecutive, but rather, in a rolling 12 month period.  By saying “in not more than three months” it would appear that the Federal Reserve is implying that transfers may occur in up to three months (out of a 12 month rolling period) and when the fourth month occurs, a financial institution is not permitted to “continue to consider an account an MMDA.” Thus, it appears to be a “four strike rule” for non-consecutive months.

In addition to this interpretation of a financial institutions responsibilities for monitoring for excessive transactions, the Federal Reserve is clear that the three-strike rule may not be sufficient in all cases to effectively comply with a financial institutions responsibilities for monitoring for excessive transactions.  Specifically, the Federal Reserve states that a significant number of excessive transactions within a single month could warrant action by the financial institution to reclassify the account sooner than waiting for three violations as referenced in the three-strike rule. The Federal Reserve guidance states the following:

[The footnote] requires institutions to monitor transfers and contact customers who exceed the limits more than occasionally.

[The footnote] provides that the rule limiting transfers need not be applied mechanically, but it does not change the fundamental requirement that a depository institution may not permit or authorize more than six transfers from an MMDA per month. Thus, if the circumstances warrant, an institution may not be required to close or reclassify an MMDA in the event of an occasional excess transfer from the account. Enforcement procedures that focus on excess transfers in consecutive months and that ignore excess transfers in any particular month would not be sufficient to prevent excess transfers from MMDAs, and would therefore fail to meet the monitoring requirements of Regulation D.

Ideally, controls on excess transfers should be sufficiently flexible to address both excess transfers in nonconsecutive months as well as the level of excess transfers in a particular month. Such controls would help depository institutions distinguish inadvertent violations of the transfer limits from abuses of the transfer limits. Thus, when a customer ignores the transfer limits applicable to an MMDA, the depository institution should take steps to close the account more quickly than it would an account from which the depositor inadvertently, and occasionally, exceeds the transfer limits by a single transfer. Nevertheless, a monitoring system that would detect and prevent all excess transfers may be costly to administer. For this reason, the Board has applied a general rule that an institution may continue to consider an account an MMDA even if there are excess transfers so long as those excess transfers are not the result of an attempt to evade the transfer limits, and if the excess transfers occur in not more than three months during any 12-month period. This working rule is not absolute, however, and the facts and circumstances must be considered in each case.

Summary of the Three-Strike Rule

As you can see, the three-strike rule isn’t always applied consistently by the Federal Reserve:

  • 3 strikes for consecutive month violations

  • 4 strikes for violations in non-consecutive months but within a rolling 12 month period

  • 1 strike when a single month has a significant number of excessive transactions exceeding the transaction limitations

The bottom line is that most financial institutions utilize a “3-strike” rule even though 4 strikes could be utilized in non-consecutive months of transaction violations. That said, it is also important to have procedures that ensure timely account closure/conversion when the number of transaction violations in a single month is significant.

Actions Needed for Excessive Transactions

So let’s now assume that a financial institution has determined that a customer has violated the provision of more than occasionally exceeding the transaction limitations.  What steps should a financial institution now take in response to this?

The Federal Reserve provides guidance in their own examination manual on Regulation D as follows:

Generally, if a savings deposit account exceeds, or is authorized to exceed, the ‘‘convenient’’ transfer limit, the bank should take away the transfer and draft capabilities of the account or close the account and place the funds in another account that the depositor is eligible to maintain. If the depositor is a natural person, the funds may be placed in a NOW account. If the depositor is not a natural person, the bank may be required to reclassify the account as a demand account, as businesses are not allowed to hold NOW accounts.

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