Seeking to reduce the volatility of short-term interest rates, the Federal Reserve Board on Wednesday proposed making it easier for banks to meet reserve requirements.
Under the Fed's plan, banks would use deposit figures that are 17 days old to compute their required reserves. Right now, current deposit levels are used.
Fed officials said the explosive growth of retail sweep accounts has made it increasingly difficult for banks to accurately peg reserve levels. As a result, many banks scramble to borrow money at the last minute to meet their reserve requirements. This sudden spike in demand sends overnight rates sky high. The volatility has made it tougher for the Fed to manipulate the overnight rate to control the economy.
The proposal would eliminate this last minute scramble because banks would know at least two weeks in advance how much money they need to keep in reserve.
The proposal received widespread support. "Banks will know exactly what their target is," said Bert Ely, president of Alexandria, Va., consulting firm Ely & Co. "It should ease borrowing from the Fed and reduce volatility in the Fed funds rate."
Federal Reserve Board Vice Chairman Alice M. Rivlin described the plan as a "fairly sensible thing to do."
Every other Wednesday, a bank sets reserve levels based on its average deposit levels over a two-week span. Banks now rely on estimates to set their initial reserve levels. If their estimates are wrong, banks borrow money to boost reserves.
If approved, the proposal would take effect in July 1998. It would apply to 6,100 banks and thrifts that adjust their Fed reserves every two weeks. Institutions with less than $75 million of deposits are exempted. The proposal is expected to be published shortly in the Federal Register; comments will be due 60 days later.
Also on Wednesday, the Fed proposed risk-management standards for privately operated payment systems.
Under the plan, all settlement systems would be expected to address credit, liquidity, operational, legal, and systemic risks. The Fed also proposed tougher controls for large payment systems whose failure could cause other payment systems to collapse. They would be required to have the ability to clear all transactions even if a member institution defaults on its obligations.
The policy would apply to 200 check-clearing houses, 50 automated teller machine networks, and three private-sector automatic clearing house operators. It also would cover several credit card settlement arrangements and two foreign exchange clearing houses.
The board also adopted 1998 prices for its fee-based services. Transfer fees for the Fed's electronic payment system will drop to 40 cents, from 45 cents. Combined with other cuts in automated clearing house fees, electronic payment charges will drop 11.4%, saving banks $15.6 million in 1998. Fees for check services will be unchanged. Prices are effective Jan. 2.
