Alert January 05, 2010

FRB Issues NPR under which FRB would Sell Term Deposits to Depository Institutions to Absorb Excess Liquidity in U.S. Banking System

The FRB issued a Notice of Proposed Rulemaking (“NPR”) that would amend the FRB’s Regulation D to establish a program under which the FRB would offer and sell term deposits to eligible depository institutions (“Eligible DIs”).  Under the NPR, term deposits would generally bear maturities of from one month to one year.  The interest rate paid on a term deposit would be set either through an auction process or through application of a formula.  The maximum allowable interest rate set through an auction would not be higher than the general level of short-term interest rates.  Short-term interest rates are defined by the NPR to mean:

“the primary credit rate and rates on obligations with maturities of up to one year in which eligible institutions may invest, such as rates on term federal funds, term repurchase agreements, commercial paper, term Eurodollar deposits and other similar rates.”

The FRB issued the NPR establishing term deposits to help the FRB manage and absorb excess liquidity in the U.S. banking system resulting from the extraordinarily high level of funding provided by the FRB over the past two years to combat the unprecedented economic and financial crisis.  The FRB stated that term deposits would be one of several tools the FRB could use “to drain reserves to support the effective implementation of monetary policy.”

Under the NPR, term deposits would differ from balances held by Eligible DIs in their master accounts at the FRB because the term deposits could not be withdrawn prior to maturity, would not satisfy required FRB reserve balances or contractual clearing balances and would not be available to clear payments or cover daylight or overnight overdrafts.  Term deposits, which the FRB characterized as “roughly analogous” to certificates of deposit issued by depository institutions to their customers, would be eligible for use as collateral at the FRB’s discount window.

Under the NPR, term deposits would be issued by the various federal reserve banks, but one of the federal reserve banks would be selected by the FRB to administer the term deposit program for the federal reserve system as a whole.  Comments to the NPR are due by February 1, 2010.