Banks, especially smaller ones, may be able to compete more effectively with securities firms if legislation is passed allowing banks to pay interest on business checking accounts, according to industry consultants.

The provision is included in regulatory relief legislation the Senate Banking Committee will take up Oct. 11. Under the proposal, a compromise between the large and small banks, banks’ depository institutions will be allowed to make up to 24 transfers a month into interest-bearing accounts through "sweeps" until Jan. 1, 2010. After that, banks will be allowed to offer interest-bearing accounts on all business deposits.

One community bank Second Bank & Trust in Culpeper, Va., has just teamed with Goldman Sachs & Co. to offer the Capital Manager Investment Account, a sweep account that enables customers to invest excess cash overnight in one of several money market funds sponsored by Goldman Sachs Money Market Trust.

The provision is being supported primarily by smaller institutions, which do not have the resources to program their computers to "sweep" these funds overnight into money market and similar accounts.

Larger institutions, which have opposed the provision, will also gain a sweetener under the bill, a provision that will allow the Federal Reserve Board to pay interest on reserve balances banks must hold with the Fed. Under the bill, the Fed would be allowed to pay interest on those reserve accounts at a rate "not greater than the Fed Funds rate."

Edward Furash, an adviser to banks on products and deposit issues, explained that allowing smaller institutions to pay interest on checking accounts will increase the industry’s competitiveness with securities firms. "The securities markets have been eating banks’ lunch for at least the last 15 years, draining away deposits into money market funds and savings into stocks, bonds and other investments," he said. "Intermediation volume, leadership and pricing have moved to the capital markets, and deposit pricing is set by money market mutual funds."

Steve Zeisel, of the Consumer Bankers Association in Washington, said large banks with sweep capability and securities firms have been taking this business cash and investing it in money market funds, euro deposits and cash management accounts, among other investments.

The provision has the support of Federal Reserve Board chairman Alan Greenspan. Greenspan in 1997 declined to approve a request from the American Bankers Association to re-interpret a Fed regulation so as to allow banks to make 24 transfers a month into interest-bearing accounts, saying it was contrary to law.

Similar legislation was drafted last year in both the Senate and House Banking committees, and is given a good chance of passage this year.