Interest on Reserves: Implications for Banking and Policymaking

This policy brief evaluates the banking and policy implications of 2006 Congressional legislation authorizing the Federal Reserve to pay interest on reserves held at Federal Reserve banks beginning in October 2011. This upcoming policy change has received remarkably little attention from the financial media, yet it promises to have effects along several dimensions. Likely to be impacted are total reserves held by depository institutions, the interest sensitivities of these institutions’ asset holdings, balances in sweep accounts managed by depository institutions, and depository institutions intraday overdrafts of their reserve accounts at Federal Reserve banks. In addition, the authorization to pay interest on reserves broadens the set of tools of monetary policy available to the Fed. Finally, this policy change strengthens the case for significant reductions in, or possibly elimination of, reserve requirements on U.S. depository institutions.