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What is an Earnings Allowance?

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  • Written By: Toni Henthorn
  • Edited By: W. Everett
  • Last Modified Date: 28 August 2016
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The earnings allowance is a daily bank calculation on a customer account that credits the account for its idle funds to offset bank service charges. Although each bank may set the rate using its unique formula, the bank links the rate for the earnings allowance with the United States Treasury bill interest rate. The banks afford an account with a large balance a higher earnings allowance than an account with a minimal balance, so that large account holders pay lower bank fees. The rate at which banks credit an account, called an earnings credit rate (ECR), incorporates the earnings allowance along with the rate at which the consumer utilizes various bank services. Banks exercise considerable discretion in setting the ECR.

Business account holders must decide whether to maintain high balances in order to offset bank service charges or to use the funds to invest elsewhere. The potential advantages to paying the bank fees and using the available funds include higher yields from other investments, lowered Federal Reserve and Federal Deposit Insurance Commission fees, and the ability to write-off bank charges as a business expense, which will reduce taxes. On the other hand, if high balances are maintained, the earnings allowance credit covers bank fees, and the company does not have to budget for these fees. In addition, banks may be more amenable to loans if the loan applicant has a large account in the bank.

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The Federal Open Market Committee (FOMC) sets short-term interest rates. When the committee cuts the federal interest rate to stimulate the economy, the interbank loan interest rate also falls. Because banks earn less money from account money, the earnings allowance rate and the interest rate for interest-bearing accounts also fall. On the other hand, a fall in the federal interest rates lowers adjustable rate mortgages, interest rates on other loans, and credit card interest rates. If the lower interest rates produce too much growth in the economy, inflation occurs.

Although banks credit the account holder the earnings allowance for the inert funds in his account, the best method to avoid high bank charges is to shop for the bank that provides the services needed for the lowest rate. Common bank fees include overdraft protection fees, minimum balance fees, debit card transaction fees, and automated teller transaction fees. Some banks offer checking accounts for no monthly fee, but hidden charges for extra checks or other services may offset the benefit. Alternatively, account holders may skip transaction fees by using credit cards and paying off the balance each month.

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