Vernon Smith's bank is paying him 12 percent less on his money than he thought he was getting.
"What?" Mr. Smith said yesterday as he left the downtown office of Sovran Bank/Maryland. He paused, looking confused. "If I'm losing like that, that's a whale of a loss."
With profits down and competition steep, a growing number of bank have stopped paying interest on 12 percent of their customers' checking-account balances.
The argument is this: Because the Federal Reserve requires that 12 percent of these balances be held in reserve, banks shouldn't have to pay interest on money they can't touch. Thus, an advertised rate of 5 percent means the bank pays 4.4 percent.
Rising up from the South, the so-called "investable balance" technique started in Alabama and Mississippi and spread northward, according to Hugo Ottolenghi, editorial director at the weekly Bank Rate Monitor. Moving through Florida and Georgia, it hit the Carolinas and Virginia before flowing through Maryland and into Pennsylvania.
"It's kind of like Sherman in reverse," Mr. Ottolenghi observed.
The newest participant in the area is Chevy Chase FSB, which has notified customers it will use the technique beginning today. Mr. Ottolenghi said that it is the first thrift he knows to use the technique.
It's not clear how prevalent the practice is, because no regulatory approval is needed. But a recent survey by Signet failed to turn up other institutions using it in Maryland.
Banks apparently started the practice a few years ago as part of a trend to isolate fees and reduce costs.
The technique's popularity might be short-lived. Having attracted the attention of federal regulators and lawmakers, it is under attack.
"In all honesty, I think it's dumb, stupid and near violation," said Philip A. Farley, manager of regulations assistance at the Federal Reserve Bank in Philadephia. "What it comes down to is this: Is what they're doing legal? Maybe yes, maybe no."
The furor has reached Washington. A bill called the Truth in Savings Act, which prohibits the practice, passed the House in late September and is before the Senate.
Critics argue that, while banks footnote the change and are required to tell customers, the effect of the technique is confusing, requiring depositors to refigure the rate based on 88 percent of their balance.
And the disclosures are not always easy to find.
Sovran Bank/Maryland, which has about $400 million worth of deposits in these types of accounts, does disclose the practice, but not in its glossy brochures. Customers have to look at the small-print summary of fees the bank gives to them.
No, it's not Footnote 1, which a Sovran branch manager first pointed to. Look, instead, at Footnote 7, which reads in part: "Interest is computed on the daily investable balance in the account. Daily investable balance is the ledger balance in your account less . . . the reserve requirements for transaction accounts prescribed by Regulation D. The current reserve requirement for such accounts is 12%."
Not one Sovran customer interviewed on the streets of Baltimore knew of the practice. And only Peter A. Nowakoski, a longtime businessman and chairman of Sheffield Communications in Virginia, thought it seemed proper, although he was unaware that it was done.
The industry itself is split on the technique.
"Why would a bank hurt itself by telling customers about doing this?" asked a local banking executive, who spoke on the condition of anonymity. "The accepted practice is to build it into the cost of doing business."
Lani Chisman Davis, marketing executive officer at Sovran, disagreed. She said that it was the fairest way to maintain the 5 percent rate offered on the balance while offseting the growing cost of federal deposit insurance, which has increased twice in recent years.
"We don't receive any interest on the reserve," she said. "We don't get use of them [to earn interest], and the customers don't get use of them. No one in effect is getting any benefit."
But the Federal Reserve has required for decades that financial institutions put a percentage of deposits aside in reserve. Before the creation in 1980 of NOW accounts -- the most common type of interest-bearing checking account -- reserve requirements were as high as 16.25 percent at the largest banks.
For Mr. Smith, a service manager for Genesis Office Systems Inc., it all seems too much. After rattling off a host of banking problems he has had through the years, the father of three just shrugged. "I'd just as soon not keep any money in the bank."