In banking,
excess reserves are
bank reservesBank reserves are banks' holdings of deposits in accounts with their central bank , plus currency that is physically held in bank vaults . The central banks of some nations set minimum reserve requirements...
in excess of the
reserve requirementThe reserve requirement is a bank regulation that sets the minimum reserves each bank must hold to customer deposits and notes...
set by a
central bankA central bank, reserve bank, or monetary authority is a banking institution granted the exclusive privilege to a lend a government its currency...
(in the United States, the
Federal Reserve SystemThe Federal Reserve System is the central banking system of the United States. It was created in 1913 by the enactment of the Federal Reserve Act, largely as a response to a series of financial panics or bank runs, particularly a severe panic in 1907...
, called the Fed; in
CanadaCanada is a country occupying most of northern North America, extending from the Atlantic Ocean in the east to the Pacific Ocean in the west and northward into the Arctic Ocean...
, the
Bank of CanadaThe Bank of Canada is Canada's central bank. It was created by the Bank of Canada Act of 1934, to "promote the economic and financial well-being of Canada." It is the sole issuer of banknotes in Canada, and the central bank for the Canadian dollar....
). They are reserves of cash more than the required amounts. Holding excess reserves is generally considered costly and uneconomical as no interest is earned on the excess amount. Therefore, many banks minimize their excess reserve amounts by putting them to more productive use.
For banks in the U.S.
In banking,
excess reserves are
bank reservesBank reserves are banks' holdings of deposits in accounts with their central bank , plus currency that is physically held in bank vaults . The central banks of some nations set minimum reserve requirements...
in excess of the
reserve requirementThe reserve requirement is a bank regulation that sets the minimum reserves each bank must hold to customer deposits and notes...
set by a
central bankA central bank, reserve bank, or monetary authority is a banking institution granted the exclusive privilege to a lend a government its currency...
(in the United States, the
Federal Reserve SystemThe Federal Reserve System is the central banking system of the United States. It was created in 1913 by the enactment of the Federal Reserve Act, largely as a response to a series of financial panics or bank runs, particularly a severe panic in 1907...
, called the Fed; in
CanadaCanada is a country occupying most of northern North America, extending from the Atlantic Ocean in the east to the Pacific Ocean in the west and northward into the Arctic Ocean...
, the
Bank of CanadaThe Bank of Canada is Canada's central bank. It was created by the Bank of Canada Act of 1934, to "promote the economic and financial well-being of Canada." It is the sole issuer of banknotes in Canada, and the central bank for the Canadian dollar....
). They are reserves of cash more than the required amounts. Holding excess reserves is generally considered costly and uneconomical as no interest is earned on the excess amount. Therefore, many banks minimize their excess reserve amounts by putting them to more productive use.
For banks in the U.S. Federal Reserve System, this is accomplished by making short-term (usually overnight) loans on the
federal fundsIn the United States, federal funds are overnight borrowings by banks to maintain their bank reserves at the Federal Reserve. Banks keep reserves at Federal Reserve Banks to meet their reserve requirements and to clear financial transactions...
market to banks who may be short of their reserve requirements. However, some banks may choose to hold their excess reserves in order to facilitate upcoming transactions or meet contractual clearing balance requirements.
Emergency Economic Stabilization Act of 2008
On October 3, 2008, Section 128 of the Economic Stabilization Act of 2008 allowed the Fed to begin paying interest on excess reserve balances as well as
required reservesThe reserve requirement is a bank regulation that sets the minimum reserves each bank must hold to customer deposits and notes...
. They began doing so three days later. Banks had already begun increasing the amount of their money on deposit with the Fed at the beginning of September, up from about $10 billion total at the end of August, 2008, to $880 billion by the end of the second week of January, 2009. In comparison, the increase in reserve balances reached only $65 billion after September 11, 2001 before falling back to normal levels within a month. Former
U.S. Treasury SecretaryThe United States Secretary of the Treasury is the head of the United States Department of the Treasury, concerned with finance and monetary matters, and, until 2003, some issues of national security and defense. This position in the Federal Government of the United States is analogous to the...
Henry PaulsonHenry Merritt "Hank" Paulson, Jr. served as the 74th United States Treasury Secretary. He previously served as the Chairman and Chief Executive Officer of Goldman Sachs...
's original bailout proposal under which the government would acquire up to $700 billion worth of mortgage-backed securities contained no provision to begin paying interest on reserve balances.
The day after the change was announced, on October 7, Fed Chairman
Ben BernankeBen Shalom Bernanke is an American economist, the former chair of the department of Economics at Princeton University and the current Chairman of the Federal Reserve of the United States Federal Reserve. Bernanke succeeded Alan Greenspan on February 1, 2006...
expressed some confusion about it, saying, "We're not quite sure what we have to pay in order to get the market rate, which includes some credit risk, up to the target. We're going to experiment with this and try to find what the right spread is." The Fed adjusted the rate on October 22, after the initial rate they set October 6 failed to keep the benchmark U.S. overnight interest rate close to their policy target, and again on November 5 for the same reason.
The
Congressional Budget OfficeThe Congressional Budget Office is a federal agency within the legislative branch of the United States government. It is a government agency that provides economic data to Congress....
estimated that payment of interest on reserve balances would cost the American taxpayers about one tenth of the present 0.25% interest rate on $800 billion in deposits:
Estimated Budgetary Effects
| Year |
2006 |
2007 |
2008 |
2009 |
2010 |
2011 |
2012 |
2013 |
2014 |
2015 |
2016 |
| Millions of dollars |
0 |
-192 |
-192 |
-202 |
-212 |
-221 |
-242 |
-253 |
-266 |
-293 |
-308 |
| (Negative numbers represent expenditures; losses in revenue not included.) |
0.25% simple interest on $800 billion is $2 billion, not $202 million as shown for 2009. But those expenditures pale in comparison to the lost tax revenues world-wide resulting from decreased economic activity from damage to the short-term
commercial paperIn the global money market, commercial paper is an unsecured promissory note with a fixed maturity of 1 to 270 days. Commercial Paper is a money-market security issued by large banks and corporations to get money to meet short term debt obligations , and is only backed by an issuing bank or...
and associated credit markets.
Beginning December 18, the Fed directly established interest rates paid on required reserve balances and excess balances instead of specifying them with a formula based on the target federal funds rate. On January 13,
Ben BernankeBen Shalom Bernanke is an American economist, the former chair of the department of Economics at Princeton University and the current Chairman of the Federal Reserve of the United States Federal Reserve. Bernanke succeeded Alan Greenspan on February 1, 2006...
said, "In principle, the interest rate the Fed pays on bank reserves should set a floor on the overnight interest rate, as banks should be unwilling to lend reserves at a rate lower than they can receive from the Fed. In practice, the federal funds rate has fallen somewhat below the interest rate on reserves in recent months, reflecting the very high volume of excess reserves, the inexperience of banks with the new regime, and other factors. However, as excess reserves decline, financial conditions normalize, and banks adapt to the new regime, we expect the interest rate paid on reserves to become an effective instrument for controlling the federal funds rate."
Also on January 13,
Financial Week said Mr. Bernanke admitted that a huge increase in banks' excess reserves is stifling the Fed's monetary policy moves and its efforts to revive private sector lending. On January 7, 2009, the
Federal Open Market CommitteeThe Federal Open Market Committee , a component of the Federal Reserve System, is charged under United States law with overseeing the nation's open market operations. It is the Federal Reserve committee that makes key decisions about interest rates and the growth of the United States money supply....
had decided that, "the size of the balance sheet and level of excess reserves would need to be reduced." On January 15,
Chicago FedThe Federal Reserve System is the central banking system of the United States. It was created in 1913 by the enactment of the Federal Reserve Act, largely as a response to a series of financial panics or bank runs, particularly a severe panic in 1907...
president and Federal Open Market Committee member Charles Evans said, "once the economy recovers and financial conditions stabilize, the Fed will return to its traditional focus on the federal funds rate. It also will have to scale back the use of emergency lending programs and reduce the size of the balance sheet and level of excess reserves. 'Some of this scaling back will occur naturally as market conditions improve on account of how these programs have been designed. Still, financial market participants need to be prepared for the eventual dismantling of the facilities that have been put in place during the financial turmoil,' he said."
At the end of January, 2009, excess reserve balances at the Fed stood at $793 billion but less than two weeks later on February 11, total reserve balances had fallen to $603 billion. On April 1, reserve balances had again increased to $806 billion.