Picking Apart the Penalty Provisions of Regulation D
Just like the old “tongue twisters” we chanted during recess in elementary school, the penalty provisions set forth in Regulation D for time deposits can be a bit puzzling.
Questions regarding time deposits and penalties arise quite frequently in the current culture of “penalty free” or “one time penalty free withdrawal” time deposits offered by Financial Institutions.
Those questions often include:
- Can the financial institution advertise and disclose those time deposits – also referred to as Certificates of Deposit or Share Certificates – as penalty free?
- Can the financial institution can waive all penalties for early withdrawal?
- Which regulation requires those penalties on early withdrawals?
Let’s review the requirement for assessing an early withdrawal penalty, and how it should be disclosed.
A time deposit, like a savings account, is not a transaction account. Regulation D states that a time deposit does not allow the accountholder to withdraw funds within the first six days of initial deposit unless the financial institution assesses a penalty of at least seven days’ interest.
In general, an institution is required to assess the early penalty withdrawal on a time deposit account in two instances. Section 204.2(c)(1) of Regulation D generally provides that the customer does not have the right to make a withdrawal after six days of making the deposit unless a penalty of at least seven days’ simple interest is assessed on the amount withdrawn. Although Footnote 1 within Regulation D states that the early withdrawal penalty may be waived for certain instances, generally a penalty of at least seven days’ simple interest on the amount withdrawn is required to be assessed within six days of any partial withdrawal as well as six days of the initial deposit at account opening. This is to deter customers from making partial withdrawals every six days. If the institution allows the customer to make withdrawals every six days without assessing a penalty, then the account no longer meets the definition of a time deposit and becomes either a savings account or a transaction account.
To simplify, let’s take a look at an example. A consumer opens an eight-month time deposit on May 1, and three days later, on May 4, requests to withdraw $1,000 from the account. If the institution agrees to allow the withdrawal, it must charge a minimum of seven days’ simple interest on the $1,000. The institution may charge more if they have disclosed such, but they may not waive the penalty or charge less than the seven days of simple interest. Now, let’s say the same account holder returns six days after the $1,000 partial withdrawal and requests another $500. What happens next? If you said the institution is required to charge another early withdrawal penalty of at least seven days’ simple interest, you are correct.
If the time deposit allows the customer or member to make additional deposits during the term, the minimum early withdrawal penalty will apply to each subsequent deposit as well. For example, let’s say customer or member opens a time deposit with a two-year term and is allowed to make additional deposits throughout the term. If 30 days after opening the account the customer or member deposits an additional $500 and requests a withdrawal of $1,000 within six days of that $500 deposit, the withdrawal will be subject to the early withdrawal penalty of at least seven days’ simple interest.
Although the requirement to assess a penalty depends on the timing of the early withdrawal, there may be instances in which the financial institution can waive the penalty. For example, if the accountholder requests a partial withdrawal from the time deposit 10 days after the initial deposit or subsequent deposits (or 10 days after a prior partial withdrawal), the institution may, but is not required to, charge an early withdrawal penalty. Whether the institution will charge or waive the penalty depends upon the situation and the institution’s policy. If the institution chooses to have the option of waiving the penalty, then it should use the word “may” when describing the early withdrawal penalty in the TISA disclosure. Using the word “may” instead of “will” provides flexibility in case the institution chooses to waive a penalty.
Now, what about those time deposits described as “one time penalty free withdrawal” or “penalty free”? Some institutions offer a “one time penalty free withdrawal” on longer-term time deposits. This can be offered and still comply with the required Regulation D withdrawal penalties as long as the financial institution assesses the early withdrawal penalty under the required instances mentioned previously. To avoid confusing or misleading the customer or member (and to avoid any potential UDAAP violations), institutions must clearly disclose the limitations.
Unfortunately, we cannot say the same of the “penalty free” time deposits. You cannot advertise a time deposit as “penalty free” because of the required withdrawal penalty under Regulation D. Where you are required to assess a penalty if the customer makes a withdrawal within six days of the initial or subsequent deposits or within six days of a previous withdrawal, you cannot describe the product as penalty free. Doing so could be considered misleading and could raise a potential UDAAP.
At the end of the day, Regulation D and the Federal Reserve Act set forth the minimum required penalties for time deposits. Your institution is permitted to impose greater penalties as long as they are clearly disclosed in writing at the time of account opening. If your institution chooses to waive a penalty that is not required by Regulation D, you may do so; however, ensure applicable disclosures state that a penalty “may” be charged instead of a penalty “will” be charged.
Now that we have completed picking apart the penalty provisions of Reg D, just for fun, try saying that 10 times as fast as you can. Have a great week.