Bank Deposit Products and Earnings Credit

Why This Topic Matters
Bank deposit products and earnings credit sit at the heart of the Corporate Liquidity Management domain of the AFP Certified Treasury Professional (CTP) exam. Every treasury professional must decide where to hold operating cash, how to compensate banks for services, and how to balance safety, liquidity, and yield. The exam tests this area because it combines conceptual knowledge (what each deposit product is and how it is regulated) with practical calculation (how an account analysis statement converts balances into credits that offset fees). Candidates who understand this topic can answer both the definitional questions and the numerical problems that reliably appear on the exam, and the same knowledge is used daily on the job when negotiating bank relationships and optimizing idle cash.

What Bank Deposit Products Are
Bank deposit products are the accounts a corporation holds at a financial institution to receive, hold, and disburse funds. The CTP body of knowledge groups them into several categories:

1. Demand Deposit Accounts (DDAs)
These are standard checking accounts from which funds can be withdrawn on demand without notice. DDAs are the workhorse of corporate cash management, used for collections, disbursements, and concentration. Historically, Regulation Q prohibited banks from paying explicit interest on corporate demand deposits; this prohibition was repealed by the Dodd-Frank Act effective July 2011, so banks may now pay hard interest on business DDAs. In practice, many corporations still earn value on DDA balances through the earnings credit mechanism discussed below rather than through explicit interest.

2. Interest-Bearing Transaction Accounts
Negotiable Order of Withdrawal (NOW) accounts and similar interest-bearing checking products were long limited to individuals, sole proprietors, nonprofits, and governmental units. After the Reg Q repeal, interest-bearing checking became broadly available to corporations. The exam may still reference the historical restriction, so know both the old rule and the current state.

3. Money Market Deposit Accounts (MMDAs)
MMDAs are savings-type deposits that pay a market-related interest rate. They historically carried a limit of six preauthorized or third-party transfers per month under Regulation D (a restriction the Federal Reserve relaxed in 2020). MMDAs are FDIC insured and are often used as a parking place for short-term excess liquidity.

4. Time Deposits and Certificates of Deposit (CDs)
A time deposit has a fixed maturity and typically carries an early-withdrawal penalty. Certificates of deposit are the most common form. Negotiable CDs are large-denomination (typically $100,000 or more, often $1 million or more in the institutional market) instruments that can be sold in a secondary market before maturity, which improves liquidity relative to a non-negotiable CD. Eurodollar deposits are dollar-denominated time deposits held at banks outside the United States or at International Banking Facilities; they are not FDIC insured and are not subject to U.S. reserve requirements, which historically allowed them to pay slightly higher yields.

5. Specialized Account Structures
Although not deposit products in the pure sense, the exam links several account structures to deposit management:
- Zero Balance Accounts (ZBAs): subsidiary accounts that are swept to or funded from a master concentration account at the end of each day so that the subsidiary balance is zero.
- Sweep accounts: arrangements in which balances above a target level are automatically invested overnight (in money market funds, repurchase agreements, Eurodollar deposits, or an offshore sweep) and returned the next morning. Sweeps convert idle DDA balances into interest income.
- Controlled disbursement accounts: accounts that provide early-morning notification of the day's check presentments so the treasurer can fund exactly the amount needed.

6. Deposit Insurance
The FDIC insures deposits up to $250,000 per depositor, per insured bank, per ownership category. Corporate balances almost always exceed this limit, so treasurers rely on the bank's credit quality, collateralization (for public funds), reciprocal deposit networks, or sweeps into investments to manage counterparty exposure. The Transaction Account Guarantee program that provided unlimited insurance on noninterest-bearing transaction accounts expired at the end of 2012.

What Earnings Credit Is
The earnings credit is a non-cash allowance a bank grants a corporate customer based on the balances the customer leaves in its deposit accounts. The bank applies an Earnings Credit Rate (ECR) to the balances available for the bank to invest and uses the resulting Earnings Credit Allowance (ECA) to offset the fees charged for cash management services such as wires, ACH origination, lockbox processing, account maintenance, and information reporting. Earnings credit is often described as soft dollar compensation, in contrast to hard dollar compensation in which the company simply pays fees in cash.

Key characteristics of earnings credit that the exam emphasizes:
- It is not interest. It cannot be withdrawn as cash and is not reported as taxable income to the company.
- The ECR is set by the bank, typically referenced to a short-term rate such as the 91-day Treasury bill rate or the federal funds rate, and the bank may change it at its discretion.
- Excess earnings credit in a given month generally cannot be carried forward (although some banks permit limited carryforward within a quarter or year) and is never paid out, so maintaining balances well above what is needed to cover fees wastes value.
- Because earnings credit is not taxed, it can be compared with explicit interest only on an after-tax basis: a 2.0% ECR is equivalent to a taxable hard-interest rate of 2.0% ÷ (1 − tax rate).

How the Account Analysis Works
The bank summarizes the balance-and-fee relationship each month in an account analysis statement. Understanding the flow is essential for both conceptual and calculation questions.

Step 1: Start with the average ledger balance. This is the balance shown on the bank's books, including deposited items that have not yet been collected.

Step 2: Subtract deposit float to get the average collected balance. Collected balances are the funds actually available. Only collected balances earn credit. If the account was overdrawn on a collected basis on some days, the bank will typically charge a negative collected balance fee.

Step 3: Subtract the reserve requirement to get the investable (or available) balance. Banks historically deducted a reserve requirement (10% on transaction accounts for most of the past several decades) because reserves held at the Federal Reserve earned nothing or little for the bank. In March 2020 the Fed set reserve requirement ratios to zero, and many banks eliminated the deduction, but the exam has long tested the 10% figure and many banks still deduct a percentage. Always use the reserve percentage given in the question. Some banks also deduct an FDIC assessment pass-through charge expressed in basis points on the ledger balance; treat this as an additional fee if the problem mentions it.

Step 4: Apply the ECR for the number of days in the period.
Earnings Credit Allowance = Investable Balance × ECR × (Days in Period ÷ Days in Year)
Most banks and most exam questions use a 365-day year, but read carefully; a 360-day year will be stated if it applies.

Step 5: Compare the allowance to total service charges. If the allowance exceeds charges, the company usually forfeits the surplus. If charges exceed the allowance, the company pays the shortfall in hard dollars (sometimes called a balance deficiency fee or simply a net fee due).

Worked Example
A company has an average ledger balance of $1,200,000 and average deposit float of $200,000. The bank applies a 10% reserve requirement, an ECR of 2.00%, and a 365-day year. The analysis month has 30 days and total service charges are $2,000.

Average collected balance = $1,200,000 − $200,000 = $1,000,000
Investable balance = $1,000,000 × (1 − 0.10) = $900,000
Earnings credit allowance = $900,000 × 0.02 × (30 ÷ 365) = $1,479.45
Net fee due = $2,000 − $1,479.45 = $520.55 payable in hard dollars

Reverse Calculation: Balance Required to Cover Fees
The exam frequently asks how large a collected balance is needed to offset a given level of fees.
Required investable balance = Fees ÷ [ECR × (Days ÷ 365)]
Required collected balance = Required investable balance ÷ (1 − Reserve Requirement)

Using the same numbers: $2,000 ÷ (0.02 × 30 ÷ 365) = $1,216,667 investable; $1,216,667 ÷ 0.90 = $1,351,852 average collected balance required. Any collected balance above roughly $1.35 million produces no additional value and should be swept or invested.

Fee Compensation vs. Balance Compensation: The Decision
Treasurers must decide whether to compensate the bank with balances (earning ECR) or pay fees and invest the cash elsewhere. The comparison hinges on three variables: the ECR, the after-tax yield available on alternative short-term investments, and the company's marginal tax rate. Because earnings credit is not taxable, convert the ECR to a taxable-equivalent yield:
Taxable-equivalent ECR = ECR ÷ (1 − Tax Rate)
If the company's tax rate is 25% and the ECR is 2.00%, the taxable-equivalent rate is 2.00% ÷ 0.75 = 2.67%. If a money market fund yields 2.40% pre-tax, leaving balances at the bank is the better choice; if the fund yields 3.00%, paying fees and investing is better. Also weigh non-quantitative factors: balances cannot be carried forward, balances are exposed to bank credit risk above the FDIC limit, and some banks offer a lower fee schedule to hard-dollar payers. Many corporations use a hybrid approach, holding just enough balances to cover fees and sweeping the rest.

Related Concepts Likely to Appear
- Compensating balances on loans: a bank may require a borrower to keep a minimum balance, which raises the effective borrowing cost. This is distinct from, but conceptually similar to, balance compensation for services.
- Ledger vs. collected vs. available balance: know the differences and which one earns credit.
- Negative collected balances: effectively an intraday or daylight overdraft that the bank charges for at a rate above the ECR.
- Earnings credit on noninterest-bearing accounts vs. hard interest on interest-bearing accounts: the company cannot usually receive both on the same balance.
- Bank relationship management: the account analysis statement is the primary tool for auditing bank fees, verifying that negotiated prices were applied, and identifying unused balances.

Exam Tips: Answering Questions on Bank Deposit Products and Earnings Credit

Tip 1: Follow the exact order of deductions. Ledger balance → minus float → collected balance → minus reserve requirement → investable balance → times ECR → times day fraction. Most wrong answers on the exam come from skipping the reserve deduction or applying it to the ledger rather than the collected balance.

Tip 2: Check the day-count convention. Use 365 unless the question states 360. Also confirm the number of days in the analysis month (28, 30, or 31). Distractor answers are often built from the wrong day count.

Tip 3: Use the reserve percentage provided, not a memorized one. If the question says zero reserve, do not deduct anything. If it says 10%, deduct 10%. If no reserve is mentioned, assume none.

Tip 4: Remember that earnings credit is soft dollars. If an answer choice says the company receives a cash payment, interest income, or taxable income from earnings credit, it is wrong. If a choice says unused credit is lost at the end of the period, it is generally right.

Tip 5: Convert to after-tax terms before comparing ECR to investment yields. The ECR is effectively tax-free; divide it by (1 − tax rate) to get a taxable-equivalent rate, or multiply the investment yield by (1 − tax rate) to get an after-tax yield. Either method works, but do not compare a pre-tax yield to a raw ECR.

Tip 6: For required-balance questions, divide and then gross up. Fees divided by the periodic ECR gives the investable balance; divide again by (1 − reserve) to get collected balance. Reversing these steps or forgetting the gross-up leads to a plausible-looking but incorrect answer.

Tip 7: Know the regulatory history. Be able to state that Reg Q prohibited interest on corporate demand deposits, that Dodd-Frank repealed this in 2011, that FDIC insurance is $250,000 per depositor per bank per ownership category, and that Eurodollar deposits are outside FDIC coverage and U.S. reserve requirements.

Tip 8: Match the product to the need. Questions that describe a need (daily operating liquidity, overnight investment of idle balances, a six-month surplus, a desire to minimize subsidiary balances) are asking you to select the right product: DDA, sweep, CD or negotiable CD, ZBA, respectively. Eliminate choices that sacrifice liquidity when the scenario requires daily access.

Tip 9: Read for the word collected. If a question gives you a collected balance directly, do not subtract float again. If it gives a ledger balance and float, you must subtract. The exam deliberately mixes these presentations.

Tip 10: Think like a treasurer, not an accountant. When a question asks for the best course of action, the CTP answer usually favors holding only the balances needed to offset fees, sweeping excess into higher-yielding or safer instruments, diversifying bank exposure above the insured limit, and reviewing the account analysis statement regularly to catch billing errors and renegotiate ECR and fees.

Summary
Bank deposit products give a corporation the accounts it needs to operate, ranging from fully liquid DDAs to fixed-term CDs and offshore Eurodollar deposits. The earnings credit mechanism converts idle collected balances into a non-cash allowance that offsets service fees, with the calculation flowing from ledger balance through float and reserve deductions to the ECR and day count. Mastering the sequence of the account analysis, the after-tax comparison between soft-dollar and hard-dollar compensation, and the regulatory facts around interest and insurance will prepare you to answer both the conceptual and the quantitative questions the CTP exam presents on this topic.