On Monday, the Federal Reserve Board (“FRB”) issued an interim final rule, along with a request for public comment, which amends its Regulation D (Reserve Requirements of Depository Institutions, 12 C.F.R. Part 204) to implement new authority authorizing it to pay interest on both legally required reserve balances and excess balances placed by depository institutions at Federal Reserve Banks. The FRB indicated that it believes that the interest payments should essentially eliminate the opportunity costs of depository institutions holding required reserves and thereby promote efficiency in the banking industry. According to the FRB, the payments on excess balances will allow the Reserve Banks to expand their balance sheets as necessary to provide sufficient liquidity to support financial stability and implement FRB monetary policies. 

The Financial Services Regulatory Relief Act of 2006 originally authorized the FRB to begin paying interest on reserves effective October 1, 2011. However, the recently enacted Emergency Economic Stabilization Act of 2008, passed by Congress and signed by President Bush last week, accelerated the effective date to October 1, 2008. That provision of the legislation was requested by the FRB in view of existing financial market conditions.

The FRB indicated that interest will be paid on average required reserve balances and average excess balances maintained over a reserve maintenance period. The interest rate for legally required reserve balances will initially be the average targeted federal funds rate established by the Federal Open Market Committee over each reserve maintenance period less ten (10) basis points. Excess balances placed at federal reserve banks will initially pay the lowest targeted federal funds rate during the reserve maintenance period less seventy-five (75) basis points. The FRB noted that these formulas may be adjusted over time in light of experience and evolving market conditions.

The interim final rule also indicates that pass through correspondents (which hold reserves at Federal Reserve Banks on behalf of respondent institutions) may, but are not required to, pass interest payments on to respondents. The FRB’s initial approach is to allow correspondents and respondents to work that out amongst themselves. That approach is one of the items upon which public comment has been specifically requested.

The amendments to Regulation D will take effect on October 9, 2008. Interest will be calculated beginning with the bi-weekly reserve maintenance period ending October 22, 2008 and the weekly maintenance period ending October 15, 2008. Public comment is being accepted on the interim final rule until November 21, 2008.