Alert October 28, 2008

FRB Raises the Interest Rate That FRB Banks Pay on Excess Reserve

As discussed in the October 7, 2008 Alert, in accordance with the authority granted to the FRB under the Emergency Economic Stabilization Act of 2008, the FRB has announced that the Federal Reserve Banks (the “Reserve Banks”) will pay interest on banks’ required reserve balances and on excess balances (balances held in excess of required reserve balances and contractual clearing balances).

The FRB stated that it has started to pay interest on excess reserves, effective with the two-week reserve period beginning October 23, 2008, at a rate that is only 35 basis points below the lowest Federal Open Market Committee (“FOMC”) funds target rate.  This rate of interest is 40 basis points higher than the rate paid previously by the Reserve Bank on excess reserves. The FRB said that it believed that increasing the interest rate paid and narrowing the spread between the FOMC target funds rate and the rate paid on excess reserves would “help foster trading in the funds market at rates closer to the [FOMC] target rate.”