WASHINGTON -- The Federal Reserve Board voted Wednesday to close loopholes that some banks have used to avoid reserve requirements.
The action will force some banks to set aside additional funds in noninterest-bearing reserve accounts.
The Fed was spurred by fears that the loopholes were undermining its ability to control the money supply.
But at the same time, some members voiced exasperation that the Fed is not permitted to pay interest on reserves.
Reserves are one instrument relied on by the Fed to control the money supply. But the tool's effectiveness has declined recently because banks have discovered ways to avoid the 10% reserve requirement on transaction balances called for by Regulation D.
Because no interest is paid on these funds, the economic incentive to avoid reserving is ample.
No one knows for sure how much money has been escaping through the legal gaps, but it's thought to be in the billions of dollars.
Banks can cut their reserves substantially if funds end up in nontransaction accounts or off the balance sheet.
"We need a predictable, stable reserve base for monetary policy," said Donald Kohn, the Fed's director of monetary affairs. "But competitive pressures are pushing institutions toward finding loopholes."
The company that is expected to bear the brunt of the Fed's changes is First Union Corp., Charlotte, N.C. Spokesman Jeep Bryant confirmed that First Union would be required to add about $450 million to reserves because the Fed banned it Wednesday from offering a cash-management service that evaded the reserve requirement.
At a public board meeting, the central bankers called idle reserves a punitive tax on financial institutions. They blamed the prohibition by Congress on paying interest for prompting an explosion in creative, evasive techniques.
"If we had interest on reserves, many of these problems would go away," said Fed Governor Susan Phillips. Her comments were echoed by the other six governors.
In a telephone interview, Mr. Kohn noted that the Fed has repeatedly endorsed paying interest on reserves, "but we really haven't gotten much encouragement. I think if we got some encouragement, we would begin drafting legislation."
The Fed voted 5 to 2 to plug the loopholes. Governors Lawrence Lindsey and John LaWare voted against the revisions.
Apart from First Union, Fed officials said they had no idea how many banks would be required to boost reserves - or by how much - as the tighter rules are phased in over four months.
Other Loopholes Closed
First Union is believed to be the only bank offering the socalled sweep program that the Fed banned Wednesday, but some other practices that the Fed prohibited are thought to be more widespread.
Other changes include:
* Requiring banks to maintain transaction-account reserves against tellers' checks.
* Classifying certain multiple savings accounts as transaction accounts.
* Prohibiting netting of trust balances in determining the balance of a commingled transaction account.
* Combating abuses of a special 3% reserve tranche for small banks.
Vice Chairman David Mullins declared the loophole-closing effort "a waste of time for both banks and the Federal Reserve."
Impact on All Banks
But he added that the Fed would continue fighting "a rear-guard action" until it can pay interest on reserves.
Fed officials said even banks that haven't sidestepped the rules will be affected by the changes. "Almost everything here is going to result in some sort of operational change to the bank," said Oliver Ireland, associate general counsel at the Fed.
Chairman Alan Greenspan called the amendments "close to arbitrary."
"Nonetheless, we do have a statute to uphold," Mr. Greenspan added, urging his fellow Fed governors to "make the best of a difficult situation."
"We're counting angels on the head of a pin and similar useless activities," Mr. Lindsey said, adding that the amount of money at stake is "small potatoes."
Mr. LaWare voted against the plan, he said, because he wasn't convinced that tellers' checks should be subject to reserve requirements.
"I think this is an attempt to capture reserves in accounts that may be outside the banking system," Mr. LaWare said. Non-bank institutions are some of the major providers of tellers' checks.