Last week the Federal Reserve’s Open Market Committee released the minutes from its Oct. 29 meeting. Buried deep in the minutes was a brief mention of a possible step that even the committee members didn’t think would have much of an effect: a reduction in the interest paid to banks on the excess reserves they hold at the Fed.
This alarmed at least two executives at large banks, who expressed their displeasure in anonymous quotes to the Financial Times. Lower the interest rates you pay us on our excess reserves, the bankers said, and we might have to start charging interest on deposits that consumers and corporations hold with us.
They do stand to lose some money. Banks are obliged to hold what are called “required reserves” at the Fed, for most banks about 10 percent of deposits. Right now the Fed holds $77 billion in required reserves, which earn 0.25 percent interest. The Open Market Committee did not contemplate any changes to this. But banks can also choose to hold what’s called “excess reserves” at the Fed. Under quantitative easing, which bought bonds from banks in return for a reserve credit on the Fed’s balance sheet, excess reserves have grown to $2.3 trillion. They, too, earn interest of 0.25 percent.
This is nice work if you can get it. From the banks’ perspective, 25 basis points on $2.3 trillion of completely safe assets is worth trying to hold on to. And by sharing their dissatisfaction through the FT, they are opening a negotiation with the Fed. Take away our earnings on the excess reserves we hold with you, they are saying, and we will earn it back by charging interest on the deposits citizens hold with us.
Again, I get that they want to hold on to their interest. Not many safe assets are out there making money. But charging interest on deposits is not an obvious, natural, and unavoidable consequence of losing interest on excess reserves. Rather, it’s just something the banks happen to have the power to threaten to do.
From the FT’s article:
Banks say they may have to charge because taking in deposits is not free: they have to pay premiums of a few basis points to a US government insurance programme. “Right now you can at least break even from a revenue perspective,” said one executive, adding that a rate cut by the Fed “would turn it into negative revenue—banks would be disincentivised to take deposits and potentially charge for them”.
To guarantee the deposits a bank takes from you or me, the bank pays a small insurance premium to the Federal Deposit Insurance Corp., between 0.05 percent and 0.45 percent, depending on size, stability, and complexity. The anonymous bankers are saying that the only way they can avoid a loss on their deposits is by earning interest on their required reserves at the Fed.
If so, they are terrible bankers. Banks take deposits so they can lend against them. That’s how bankers have made money since banking was invented in Florence, and it’s why banks didn’t charge their customers interest on deposits before 2008, when the Fed first started paying interest on reserves. By saying they can only break even on deposits by turning them into excess reserves at the Fed and earning 0.25 percent interest on them, the bankers are saying an excess reserve at the Fed is the only asset they can find.
If that’s true, then they have a very big problem indeed. In October financial institutions in the U.S. had $10.9 trillion in deposits (M2), more than four times the current excess reserve at the Fed, $2.3 trillion. If you believe an anonymous executive from a large bank, that means $8.6 trillion in bank deposits is out there chasing no return, leaving banks with only two ways to pay for their FDIC premiums: by continuing to earn 0.25 percent interest on $2.3 trillion, or by breaking with all tradition in the modern history of developed economies and charging interest on deposits.
You’d believe an anonymous executive from a large bank, wouldn’t you?