In an effort to whittle the funds they must hold at the Federal Reserve, banks have increased their use of retail sweep accounts tenfold since January 1995.

Policymakers here worry that the development could drive up the Fed funds rate, or the amount that banks charge one another for overnight loans.

A Federal Reserve Board survey of bankers released Wednesday shows the value of retail sweep accounts rose to $98 billion in May 1996, up from $10 billion in January 1995.

This dramatic rise in sweep accounts decreased the amount of money banks had to reserve at the Fed because only deposit accounts are subject to reserve requirements.

Bank funds on deposit with the Fed shrank to $16.1 billion from January 1995 to May 1996, according to results of the Senior Financial Officer Survey. This $8 billion drop over the 17-month period knocked Fed reserves to a 30-year low, Fed researchers said in an analysis accompanying the survey.

Banks that need short-term funds to cover an overdraft of their reserve accounts borrow from banks with excess reserves. As these reserves dwindle, demand will outstrip supply and rates will spike, Fed economists predicted.

Retail sweep accounts are a relatively new tool. On either a daily or weekly basis, banks transfer most of a retail customer's funds out of checking accounts and into money-market deposit accounts, which are not covered by the Fed's reserve requirements.

Banks try to minimize their reserves, because the Fed does not pay interest on these funds. Banks must keep 10% reserves on deposit bases in excess of $52 million and 3% on deposit bases between $4 million and $52 million. They can keep reserves either in their vaults or with the Fed.

Fed economists James Clouse and Brian Reid said the Fed funds rate deviated dramatically in 1991, the last time banks drastically lowered reserves.

"This experience has raised concerns that the reserve market might again become more volatile as required reserve balances continue to decline," they wrote in the analysis.

The Federal Open Market Committee normally sets a target Fed funds rate. However, that rate does rise when banks begin to compete for the limited number of short-term loans available to cover overdrafts in Fed accounts.

According to the survey of 50 chief financial officers, large banks will make fewer loans if the Fed funds rate varies greatly. For example, 10% said they would be less willing to make these loans to community banks and thrifts; 16% said they would be less likely to extend the credit to brokerage houses.

Mike ter Maat, an economist at the American Bankers Association, said the reduced willingness by big banks to extend credit should be expected because these institutions are managing their reserve balances to eliminate excess funds.

In the survey, 42% of the banks said they would be more likely to store excess reserves at the Fed if they earned interest.

"The Fed is recognizing that if interest were paid on required reserves, the Fed funds market would work more efficiently," Mr. ter Maat said. "It would be better for the Fed, for large commercial banks with Fed accounts, and for smaller commercial banks."

The survey also noted that:

*Forty-eight of the banks lent an average of $521 million and borrowed $1.45 billion in overnight Fed Funds per day during the first quarter of 1996.

*90% of the banks provided overnight loans to small banks.

*All those surveyed subject small banks to maximum credit limits, and 93% rate the financial condition of the borrower as the most important factor when deciding whether to extend credit.

*60% require small banks to post collateral for overnight loans.

*The average cutoff time for an overnight loan request is 4 p.m., although 40% said they will extend credit after their deadline.

*Two-thirds of the banks said they would extend credit for more than one day to a small bank, with the average maximum loan-length hovering at 7 days.

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