WASHINGTON The Federal Reserve Board Thursday finalized changes to rules governing the calculation of interest payments on excess cash reserves held at regional Fed banks, a technical change aimed at easing the inevitable rise in federal interest rates in the future.
The changes, first announced in April, revise the interest rate payment process on excess reserves in Regulation D, which governs Reserve Requirements of Depository Institutions, to a daily calculation rather than an average rate.
Under Regulation D, banks are required to hold a certain amount of cash reserves either in their vaults or in accounts at the regional Federal Reserve Banks. Those required reserves are paid a fixed interest rate, called the Interest on Required Reserves Rate, or IORR.
If a bank chooses to hold more reserves than required at the regional Fed bank, those balances are paid a different rate, the IOER. Regulation D calculates the interest rate based on the average rate throughout a two-week "maintenance period." So, for example, if the interest rate was 2% for half of the period and 4% for the other half, the bank would be paid a 3% average rate on its excess reserves at the end of the maintenance period. However, because of this averaging, an IOER change that occurs in the midst of a maintenance period has a notable lag before it is reflected in the market.
The proposed changes would instead calculate the interest payable on excess reserves on a daily basis rather than a maintenance period average. Interest paid on the reserves themselves would continue to be paid on a maintenance period average under the proposal. The effect of the change would be to "allow the full effect of an increase in the IOER rate to show through to the daily level of short-term market rates when an IOER rate change does not coincide with the beginning of a maintenance period," according to the proposal.
The agency said that the change "is intended to enhance the effectiveness in the [Interest on Excess Reserves, or IOER] rate in moving the federal funds rate into the target range established by the Federal Open Markets Committee when changes in those rates do not coincide" with a maintenance period. However, the agency added that the change "is a matter of prudent planning and has no implications for the near-term conduct of monetary policy."