9 October 2008
[Federal Register: October 9, 2008 (Volume 73, Number 197)]
[Rules and Regulations]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
FEDERAL RESERVE SYSTEM
12 CFR Part 204
[Regulation D; Docket No. R-1334]
Reserve Requirements of Depository Institutions
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Interim final rule; request for public comment.
SUMMARY: Under authority of section 128 of the Emergency Economic
Stabilization Act of 2008, the Board is amending Regulation D, Reserve
Requirements of Depository Institutions, to direct Federal Reserve
Banks to pay interest on balances held at Reserve Banks to satisfy
reserve requirements and on balances held in excess of required reserve
balances and clearing balances. The Board is also making associated
minor changes to its clearing balance policy and the method for
recovering float costs.
DATES: Effective date: This interim final rule is effective October 9,
2008. Comments must be received on or before November 21, 2008.
ADDRESSES: You may submit comments, identified by Docket No. R-1334, by
any of the following methods:
Agency Web Site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/
Federal eRulemaking Portal: http://www.regulations.gov. Follow the
instructions for submitting comments.
E-mail: firstname.lastname@example.org. Include the docket number
in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Jennifer J. Johnson, Secretary, Board of Governors of the
Federal Reserve System, 20th Street and Constitution Avenue, NW.,
Washington, DC 20551.
All public comments are available from the Board's Web site at
submitted, unless modified for technical reasons. Accordingly, your
comments will not be edited to remove any identifying or contact
Public comments may also be viewed electronically or in paper in
Room MP-500 of the Board's Martin Building (20th and C Streets, NW.)
between 9 a.m. and 5 p.m. on weekdays.
FOR FURTHER INFORMATION CONTACT: Sophia H. Allison, Senior Counsel
(202/452-3565), Legal Division, or Margaret Gillis DeBoer, Senior
Financial Analyst (202/452-3139), Division of Monetary Affairs; for
information with respect to the clearing balance policy and float
calculations, Jonathan Mueller, Senior Financial Analyst (202-530-
6291), Division of Reserve Bank Operations and Payment Systems; for
users of Telecommunications Device for the Deaf (TDD) only, contact
(202/263-4869); Board of Governors of the Federal Reserve System, 20th
and C Streets, NW., Washington, DC 20551.
Section 128 of the Emergency Economic Stabilization Act of 2008,
enacted on October 3, 2008 (the ``2008 Act''), accelerated the
effective date of the authority for the Federal Reserve Banks to pay
earnings on balances maintained at the Reserve Banks by or on behalf of
depository institutions. The 2008 Act made this authority effective on
October 1, 2008. This authority was originally enacted in Title II of
the Financial Services Regulatory Relief Act of 2006 (the ``2006 Act'')
(Pub. L. 109-351, 120 Stat. 1966 (Oct. 13, 2006), with an original
effective date of October 1, 2011. The 2006 Act provides that such
earnings must be paid at least once each quarter at a rate not to
exceed the general level of short-term interest rates. The 2006 Act
also provides that the Board may prescribe regulations concerning the
payment of earnings, the distribution of earnings to the depository
institutions that maintain balances or on whose behalf balances are
maintained, and the responsibilities of correspondents to distribute
and credit earnings on balances maintained by the respondent on a pass-
through basis with the correspondent.
The Board is publishing this interim final rule amending Regulation
D (Reserve Requirements of Depository Institutions) to direct the
Federal Reserve Banks to pay interest on balances held at Reserve Banks
to satisfy reserve requirements (``required reserve balances'') and
balances held in excess of required reserve balances and clearing
balances (``excess balances''). Reserve Banks will not pay explicit
interest on clearing balances (balances that an institution holds to
satisfy a contractual clearing balance agreement). Clearing balances
will, however, continue to earn earnings credits under the existing
clearing balance policy, although the Board has made minor adjustments
to the calculations of earnings credits and float costs to be recovered
that are related to reserve requirements. In addition, the Board has
eliminated transitional adjustments for reserve requirements in the
event of a merger or consolidation.
In the past, the absence of interest payments on required reserve
balances acted as a tax on depository institutions' issuance of
deposits subject to reserve requirements. To the extent that depository
institutions could not satisfy reserve requirements with vault cash,
they were required to hold more balances than they otherwise would in a
non-interest-bearing account at a Reserve Bank. The absence of interest
on excess balances has meant that, when reserve supply significantly
exceeds demand, the federal funds rate can fall to as low as zero.
The ability to pay interest on balances held at Reserve Banks
should help promote efficiency and stability in the banking sector.
Paying interest on excess balances will permit the Federal Reserve to
expand its balance sheet as necessary to provide sufficient liquidity
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. Paying interest on excess
balances should also help to establish a lower bound on the federal
funds rate. Eligible institutions (defined below) will presumably be
unwilling to lend balances in the funds market at a rate much below
that paid on excess balances maintained at a Reserve Bank. In addition,
paying interest on required reserve balances will eliminate much of the
reserve tax and lessen the incentive for depository institutions to
engage in reserve avoidance behavior, which absorbs real resources and
diminishes the efficiency of the banking system.
In light of the current severe strains in financial markets, the
amendments to Regulation D will be effective on Thursday, October 9,
2008. Interest will be calculated beginning with the biweekly reserve
maintenance period ending October 22, 2008, and the weekly reserve
maintenance period ending October 15, 2008. Interest payments will
occur within the existing framework for reserve computation and
maintenance, which includes reserve averaging, carryover provisions,
and reserve deficiency charges. For both excess balances and required
reserve balances, interest will be paid on these
balances averaged over the reserve maintenance period. This approach is
consistent with the current reserves framework under which compliance
with reserve requirements is measured over either a seven-day or a
fourteen-day reserve maintenance period, depending generally on the
size of the institution. Interest will be credited to eligible
institutions 15 days after the close of the maintenance period in order
to apply reserve carryover provisions. Further details on the interim
final rule are discussed below. Although the amendments to Regulation D
are effective on October 9, the Board seeks comments on all aspects of
A. Eligible Institutions
The Act permits Federal Reserve Banks to pay interest on balances
held by or on behalf of ``depository institutions.'' The Act's
definition of ``depository institution'' has a broader meaning than the
definition of that term in section 19(b)(1)(A) of the Federal Reserve
Act and Regulation D. To avoid confusion, the Board's rule uses the
term ``eligible institution'' to refer to those institutions included
in the 2008 Act's broader definition of ``depository institution.''
Therefore, the definition of ``eligible institution'' includes the
depository institutions defined in section 19(b)(1)(A) of the Federal
Reserve Act, including banks, savings associations, savings banks and
credit unions that are federally insured or eligible to apply for
federal insurance. ``Eligible institution'' also includes trust
companies, Edge and agreement corporations, and U.S. agencies and
branches of foreign banks. The definition does not include all entities
for which the Reserve Banks hold accounts, such as entities for which
the Reserve Banks act as fiscal agents, including Federal Home Loan
Interest will be paid on average required reserve balances and
average excess balances maintained over a reserve maintenance period.
The Board has established the initial rate of interest for required
reserve balances to be the average targeted federal funds rate over the
reserve maintenance period less 10 basis points. Setting this rate
below the targeted federal funds rate reflects the fact that federal
funds loans are uncollateralized and carry some counterparty risk,
whereas deposits at the Federal Reserve Banks are free from such risk.
Therefore, establishing some spread below the funds rate reflects the
risk-free nature of a deposit at the central bank. The choice of 10
basis points is approximately equal to the average spread between the
overnight rate on repurchase agreements secured by general Treasury
collateral and the overnight rate on federal funds in recent years but
prior to the onset of the current financial turmoil.
The Board has established the rate of interest for excess balances
to be the lowest targeted federal funds rate during the reserve
maintenance period less 75 basis points. The Board believes the rate on
excess balances should be set sufficiently low to provide an incentive
for eligible institutions to trade funds in excess of required reserve
balances and clearing balances in the federal funds market, but to
provide a disincentive to trade funds at rates far below the targeted
federal funds rate. The Board may adjust the formula for the interest
rate on excess balances in light of experience and evolving market
conditions. Basing the rate on excess balances on the lowest rate,
rather than the average rate, for the reserve maintenance period will
support the funds rate better during periods when the Federal Open
Market Committee eases monetary policy. If the average targeted rate
were used, then during a maintenance period in which policy was eased,
the rate on excess balances might be too close--or even above--the new
C. Treatment of Correspondent Balances
Balances that earn interest. Correspondents provide various
services to respondent institutions, such as check and cash services.
Under the Federal Reserve Act and Regulation D, certain respondents may
also elect to pass their required reserve balances through their
correspondents to the Federal Reserve Banks for the purposes of
satisfying reserve requirements, rather than holding balances directly
with a Reserve Bank. A pass-through correspondent is responsible for
holding sufficient balances in its account at the Reserve Bank to
satisfy its own required reserve balance, its own clearing balance (if
any), and the aggregate required reserve balances of its respondents.
In addition, certain institutions may act as pass-through
correspondents under the Federal Reserve Act and Regulation D even
though they are not themselves ``eligible institutions'' under this
interim final rule, such as Federal Home Loan Banks.
Under the interim final rule, the Reserve Banks will pay interest
on required reserve balances maintained by or on behalf of an eligible
institution, even if the pass-through correspondent for the eligible
institution is itself not an eligible institution. In the case of a
pass-through correspondent that is not an eligible institution, the
required reserve balances held in the correspondent's account will be
solely those held to meet its respondent's reserve requirements. Where
the pass-through correspondent is an eligible institution, the required
reserve balances in the correspondent's account may include those
balances held by the correspondent to meet its own reserve requirement,
if any, as well as those held to meet its respondent's reserve
The interim final rule also provides that the Reserve Banks will
pay interest on excess balances held by or on behalf of eligible
institutions, even if the pass-through correspondent for the eligible
institution is itself not an eligible institution but has excess
balances in its account. Without imposing additional reporting or
accounting requirements, Reserve Banks cannot determine whether all or
part of the excess balances in a pass-through correspondent's account
at a Reserve Bank are held on behalf of respondents. In light of this
problem, and in order to avoid imposing additional reporting or
accounting burdens, the interim final rule deems all of the excess
balances held in the account of a pass-through correspondent that is
not an eligible institution to be held on behalf of that
correspondent's respondents. Accordingly, all interest received on
excess balances by such pass-through correspondents are attributable
solely to the excess balances of their respondents.\1\ This provision
enables pass-through correspondents and respondents to continue to
negotiate the structure of their contractual relationships with maximum
flexibility, including negotiations regarding the appropriate
distribution of earnings received on behalf of respondent balances.
\1\ This provision is similar to others in Regulation D
regarding the extent to which the Reserve Bank considers balances to
belong to one institution for purposes of the account relationship,
even though the funds of more than one institution may be involved.
Under Regulation D, the balances in the pass-through correspondent's
account are treated as being the property only of the correspondent
for purposes of the relationship between the correspondent and the
Reserve Bank (12 CFR 204.3(i)(2)). This provision means that the
Reserve Bank's debtor-creditor relationship is solely with the pass-
through correspondent and not with any of the correspondent's
respondents, even though the funds in the correspondent's account
may include the passed-through required reserve balances of one or
The Board requests comment on any alternative methods of
determining whether all or part of the excess
balances in a pass-through correspondent's account at a Federal Reserve
Bank are held on behalf of a respondent when the correspondent itself
is not an eligible institution. For example, would it be feasible for a
pass-through correspondent to report to the Federal Reserve the amount
or proportion of its excess balances that are held on behalf of
respondents? Should the Board require pass-through correspondents to
certify that all or a specified portion of the excess balances in its
Reserve Bank account are held on behalf of its respondents? Should the
Board require all balances held by a pass-through correspondent on
behalf of its respondent institutions to be held in a segregated
account separate from the correspondent's other funds? Would a pass-
through correspondent that was not an eligible institution be able to
track respondent balances such that it could determine what proportion
of its balances in its Reserve Bank account are held on behalf of its
respondents? Alternately, would it be reasonable for the Board to
assume that none of the pass-through correspondent's excess balances
are held on behalf of a respondent?
Passing back of interest to respondents. The interim final rule
provides that a pass-through correspondent may pass back to its
respondent the interest paid on balances held on behalf of that
respondent, but it is not required to do so. Permitting, but not
requiring, the pass-back of interest earnings is consistent with the
treatment of reserve deficiency charges in Regulation D. The Reserve
Bank assesses a deficiency charge to the account of the pass-through
correspondent for any deficiency in its account balances, even if the
deficiency is attributable to a respondent. It is left to the pass-
through correspondent to determine whether to assess a deficiency
charge on the respondent, or whether to make any adjustments in other
aspects of the correspondent-respondent relationship to deal with
attribution of deficiency and other charges.
This approach also avoids interfering with existing arrangements
between pass-through correspondents and respondents for services,
including sweep arrangements or compensating balance requirements.
Correspondent banks typically structure their respondent relationships
in myriad ways, depending on a number of factors, such as services
provided or balances held. Respondents may adjust the level of balances
held with a correspondent in response to changes in the rates paid to
them or other factors. Respondents that are not satisfied with their
existing arrangements with a correspondent may take steps to
renegotiate the terms of the relationship or even seek another
The Board requests comment on whether it should require, rather
than permit, pass-through correspondents to pass back to their
respondents the interest payments on balances held on behalf of those
respondents. Would that requirement significantly interfere with
existing correspondent-respondent arrangements? Would pass-through
correspondents be able to track respondent balances such that they
could determine how to allocate the interest among their respondents?
How would the Federal Reserve ensure that all interest belonging to a
respondent had in fact been passed back?
Exemption from Regulation Q. Many eligible institutions are subject
to statutory and regulatory prohibitions against payment of interest on
demand deposits (see, e.g., 12 U.S.C. 461(i); Regulation Q (Prohibition
Against Payment of Interest on Demand Deposits), 12 CFR part 217)). The
2006 Act, however, expressly authorizes the Board to prescribe
regulations to allow pass-through correspondents to pass interest back
to respondents. Congress therefore contemplated that pass-through
correspondents could pass back part or all of the interest received in
a correspondent's Reserve Bank account to its respondents, even though
the payment of interest on demand deposit accounts is still otherwise
prohibited. The interim final rule, therefore, clarifies that when a
pass-through correspondent passes back to its respondent interest paid
on balances held on behalf of that respondent, such a payment is not a
payment of interest on a demand deposit for purposes of Regulation Q.
D. Transitional Adjustments in Mergers
The Board is eliminating the provisions in Regulation D relating to
merger-related adjustments to reserve requirements.\2\ These
provisions, currently set forth in Sec. 204.4 of the regulation, were
originally intended to phase-in the burden associated with the higher
reserve requirements that result from a merger or consolidation of
depository institutions. When two or more separate institutions merge
or consolidate into a single institution, the surviving institution
typically has a reserve requirement that is higher than the sum of the
reserve requirements of the merging institutions. The requirement is
higher because the merged institution receives only one low reserve
tranche and one exemption amount, while, prior to the merger, each
institution had a low reserve tranche and an exemption amount.\3\
Section 204.4 of Regulation D permits a phase-in of the higher reserve
tax associated with a merger or consolidation over seven quarters.
Interest on required reserve balances offers a much more effective
method to address the reserve tax associated with mergers or
consolidations because the interest earned essentially eliminates the
additional tax. Moreover, the length of the adjustment period is
sufficiently long that many institutions become part of subsequent
mergers, resulting in significant complexities in required reserves
calculations. The Board believes that paying interest on required
reserve balances effectively negates the need for the complex
adjustment provisions and therefore has deleted them in the interim
\2\ Adjustments associated with mergers completed prior to
October 9, 2008, will be left in place, but no new adjustments would
be issued on or after October 9, 2008.
\3\ The exemption amount is the amount of an institution's
reservable liabilities that are subject to a zero-percent reserve
requirement; currently it is set at $10.3 million. The low reserve
tranche is the amount of an institution's reservable liabilities
that is subject to the three-percent reserve requirement ratio;
currently, it is set at 44.4 million.
E. Clearing Balance Policy Adjustments
Clearing balances provide a way for depository institutions to hold
additional balances at the Reserve Banks to meet their clearing needs.
These balances currently earn implicit interest in the form of earnings
credits that can be used to cover the cost of Federal Reserve priced
services. Under the current methodology for pricing Federal Reserve
services, the level of clearing balances affect both costs and revenues
for Federal Reserve priced services.
In light of the revisions to Regulation D, the Board has approved
two related changes to the method in which earnings credits are
calculated, along with a similar change to the method in which float
costs to be recovered are computed. These changes discontinue practices
related to reserve requirements that are no longer necessary. These
adjustments previously had been made to ensure that respondents viewed
balances at the Federal Reserve Banks and balances at a private-sector
correspondent as equivalent.
The first earnings credit adjustment, called the ``imputed reserve
requirement adjustment,'' imputes a marginal reserve requirement ratio
of 10 percent to the Reserve Banks because a private-sector
correspondent would be required to
hold reserves against a respondent's balance. If the correspondent had
a marginal reserve requirement ratio of 10 percent, then it would grant
credits to the respondent based on only 90 percent of the respondent's
balance because it would have to hold the remaining 10 percent in the
form of non-interest-earning reserves. The Board has eliminated this
adjustment because the reserves on the respondent's balance would now
earn interest at the rate on required reserve balances.
The second earnings credit adjustment, called the ``marginal
reserve requirement adjustment,'' adjusts for the fact that the
respondent could deduct the balance held at a correspondent, but not at
the Reserve Bank, from its reservable liabilities. The reserve
requirement reduction is equal to the respondent's marginal reserve
requirement ratio multiplied by the balance at the correspondent. This
reduction has value to the respondent when it frees up balances that
can be invested in interest-bearing instruments, such as a federal
funds loan. The Board has eliminated this adjustment because the
respondent will now be indifferent between holding balances at the
Reserve Bank, and earning the rate on required reserves, or maintaining
the balance at a private-sector correspondent, taking the due from
deduction, and investing those funds.
The Board has also eliminated the imputed reserve requirement
adjustment and adjustment for cash items in the process of collection
that is applied when measuring float costs to be recovered by Federal
Reserve priced services. The Reserve Banks will now have to recover 100
percent of float costs. Previously, floats costs recovered by priced
services were reduced by 10 percent. The adjustment imputed a reserve
requirement to the Reserve Bank, but it also allowed the Reserve Banks
to adjust the imputed required reserves by the adjustment for cash
items. This approach mirrored that of a private-sector correspondent.
There is no longer a need to impute a reserve requirement to the
Reserve Banks because the private-sector correspondent will now earn
interest on its required reserve balance. As a result, the Reserve
Banks are no longer entitled to an adjustment for cash items.
Administrative Procedure Act
In accordance with the Administrative Procedure Act (``APA'')
section 553(b) (5 U.S.C. 553(b)), the Board finds, for good cause, that
providing notice and an opportunity for public comment before the
effective date of this rule would be contrary to the public interest.
In addition, pursuant to APA section 553(d) (5 U.S.C. 553(d)), the
Board finds good cause for making this amendment effective without 30
days advance publication. The Board has adopted this rule in light of,
and to help address, the continuing unusual and exigent circumstances
in the financial markets. This rule provides tools for carrying out
monetary policy more effectively. Thus, the Board believes that any
delay in implementing the rule would prove contrary to the public
interest and would be contrary to Congress's intent in accelerating the
Board's authority to use these new tools to help address current market
conditions. The Board is requesting comment on all aspects of the rule
and will make any changes that it considers appropriate or necessary
after review of any comments received.
Regulatory Flexibility Act
The Regulatory Flexibility Act requires an agency that is issuing a
final rule to prepare and make available a regulatory flexibility
analysis that describes the impact of the final rule on small entities.
5 U.S.C. 603(a). The Regulatory Flexibility Act provides that an agency
is not required to prepare and publish a regulatory flexibility
analysis if the agency certifies that the final rule will not have a
significant economic impact on a substantial number of small entities.
5 U.S.C. 605(b).
Pursuant to section 605(b), the Board certifies that this interim
final rule will not have a significant economic impact on a substantial
number of small entities. The rule implements a program for paying
interest on certain balances held by eligible institutions at the
Federal Reserve Banks and will benefit small institutions that receive
such interest. There are no new reporting, recordkeeping, or other
compliance requirements associated with this rule.
Paperwork Reduction Act
In accordance with the Paperwork Reduction Act (44 U.S.C. 3506; 5
CFR part 1320 Appendix A.1), the Board has reviewed the interim final
rule under authority delegated to the Board by the Office of Management
and Budget. The rule contains no collections of information pursuant to
the Paperwork Reduction Act.
Section 772 of the Gramm-Leach-Bliley Act requires the Board to use
``plain language'' in all proposed and final rules. In light of this
requirement, the Board has sought to present the interim final rule in
a simple and straightforward manner. The Board invites comment on
whether the Board could take additional steps to make the rule easier
List of Subjects in 12 CFR Part 204
Banks, banking, Reporting and recordkeeping requirements.
Authority and Issuance
For the reasons set forth in the preamble, the Board is amending 12 CFR
part 204 as follows:
PART 204--RESERVE REQUIREMENTS OF DEPOSITORY INSTITUTIONS
1. The authority citation for part 204 continues to read as follows:
Authority: 12 U.S.C. 248(a), 248(c), 371a, 461, 601, 611, and
2. Section 204.4 is removed and reserved.
Sec. 204.4 [Reserved]
3. Section 204.10 is added to read as follows:
Sec. 204.10 Payment of interest on balances.
(a) Payment of interest. The Federal Reserve Banks shall pay
interest on balances maintained at Federal Reserve Banks by or on
behalf of an eligible institution as provided in this section and under
such other terms and conditions as the Board may prescribe.
(b) Rate. Except as provided in paragraph (c) of this section,
Federal Reserve Banks shall pay interest at the following rates--
(1) For required reserve balances, at the average targeted federal
funds rate over the reserve maintenance period less 10 basis points;
(2) For excess balances, at the lowest targeted federal funds rate
during the reserve maintenance period less 75 basis points.
(c) Pass-through balances. Any excess balance held by a pass-
through correspondent that is not an eligible institution is deemed to
be held on behalf of the pass-through correspondent's respondents. A
pass-through correspondent may pass back to its respondent interest
paid on balances held on behalf of that respondent. Such a payment is
not a payment of interest on a demand deposit for purposes of Part 217
of this chapter (Regulation Q).
(d) Definitions. For purposes of this section--
(1) Clearing balance means the amount that an eligible institution
holds to satisfy a contractual clearing balance agreement with a
Federal Reserve Bank, in addition to any required reserve balance.
(2) Eligible institution means--
(i) Any depository institution as described in Sec. 204.1(c) of
(ii) Any trust company;
(iii) Any corporation organized under section 25A of the Federal
Reserve Act (12 U.S.C. 611 et seq.) or having an agreement with the
Board under section 25 of the Federal Reserve Act (12 U.S.C. 601 et
(iv) Any branch or agency of a foreign bank (as defined in section
1(b) of the International Banking Act of 1978, 12 U.S.C. 3101(b)).
(3) Excess balance means the average balance held in an account at
a Federal Reserve Bank by or on behalf of an eligible institution over
a reserve maintenance period that exceeds the sum of the required
reserve balance and any clearing balance.
(4) Required reserve balance means the average balance held in an
account at a Federal Reserve Bank by or on behalf of an eligible
institution over a reserve maintenance period to satisfy the reserve
requirements of this part.
(5) Targeted federal funds rate means the federal funds rate
established from time to time by the Federal Open Market Committee.
By order of the Board of Governors of the Federal Reserve
System, October 6, 2008.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. E8-24003 Filed 10-8-08; 8:45 am]
BILLING CODE 6210-01-P