Fed pay on reserves starts Oct. 9

WASHINGTON (10/7/08)—The Federal Reserve Board has announced that effective Oct. 9 it will begin to pay interest on credit unions' and other depository institutions' required and excess reserve balances.

The Financial Services Regulatory Relief Act of 2006 gave the Fed authority starting in 2011 to lower reserves to zero and/or to pay interest--not to exceed other short-term rates--on the reserve balances actually maintained.

The new Emergency Economic Stabilization Act gives the Fed that authority starting now. The authority is being implemented through changes to the Fed's Regulation D.

While the action is effective immediately, the Fed will accept public comments until Nov. 21 and the proposal will soon be published in the Federal Register. The Fed said it will adjust the rule as appropriate in light of comments.

Reserve balances are balances held to satisfy depository institutions' reserve requirements and excess balances are those held in excess of required reserving balances and clearing balances.

The Fed announcement said the interest rate paid on required reserve balances will be the average targeted federal funds rate established by the Federal Open Market Committee over each reserve maintenance period less 10 basis points.

Paying interest on required reserve balances should essentially eliminate the opportunity cost of holding required reserves, promoting efficiency in the banking sector," according to the Fed.

The rate paid on excess balances will be set initially as the lowest targeted federal funds rate for each reserve maintenance period less 75 basis points. The formula for the interest rate on excess balances may be adjusted subsequently in light of experience and evolving market conditions.

"Paying interest on excess balances should help to establish a lower bound on the federal funds rate...The payment of interest on excess reserves will permit the Federal Reserve to expand its balance sheet as necessary to provide the liquidity necessary to support financial stability while implementing the monetary policy that is appropriate in light of the System's macroeconomic objectives of maximum employment and price stability," the Fed notice claimed.

The Fed has also made several other amendments to Reg D, including the treatment of balances maintained by pass-through correspondents and eliminating transitional adjustments for reserve requirements in the event of a merger or consolidation.

The Board also published the annual adjustments for reserve requirements and reporting requirements for depository institutions.

For 2009, the first $10.3 million in net transaction accounts will be exempt from the reserve requirements. This figure is the reservable liabilities exemption adjustment.

Transaction account amounts over $10.3 million up to and including $44.4 million will have a three percent reserve requirement. Transaction account amounts over $44.4 million will have a 10 percent reserve requirement. This figure, $44.4 million, is known as the low reserve tranche.

The Credit Union National Association (CUNA) has worked hard to achieve changes in reserve requirements.

Our preference is for Reg D reserve requirements to be completely eliminated, but paying interest on reserves certainly is an improvement over holding what is referred to as 'sterile reserve,'" said CUNA Senior Vice President of Compliance Kathy Thompson Monday.

courtesy of cuna.org