Deposit Interest Ceiling and the Cost of Bank Borrowing

Created under the power of the Banking Act of 1933, Regulation Q was designed to control the cost of bank borrowing by curbing competition for deposit liabilities, a factor thought to induce investment in high-yield risky assets. Although a number of studies in recent years have sought to assess effects of the ceiling on the value of interest received by depositors, no similar attempt has been made to determine its impact in terms of the Act's legal intent. This empirical study fills the void. Our estimates show that the Act in general and the ceiling in particular have been largely ineffective in decreasing bank costs. The law has effected only a 13 percent reduction in the cost of soliciting deposits, a finding explained by evidence that cash payments represented only 15 percent of the total interest paid before 1933 and 11 percent since, while preferential credit terms accounted for as much as 80 percent of the interest paid before 1933 and 72 percent since. In view of the composition of interest paid before 1933, the ineffectiveness of a regulatory constraint focusing on cash payment of interest could have been predicted prior to enactment. Notwithstanding long-term effects, there is some indication that the ceiling has been more effective during periods of high market interest rates