2oii0r2017 Excess Reserves Excess Reserves What are 'Excess Reserves! Excess reserves ae capital reserves held by a bank or financial institution in excess of what is required by regulators, creditors or internal controls, For commercial banks, excess reserves are measured against standard reserve requirement amounts set by central banking authorities. These required reserve ratios st the minimum liquid deposits (such as cash) that must be in reserve ata bank; more is considered excess. BREAKING DOWN 'Excess Reserves’ Financial firms that carry excess reserves have an extra measure of safety inthe event of sudden loan loss o significant cash withdrawals by customers. This buffer increases the safety ofthe banking, system, especallyin times of economic uncertainty. Boosting the level of exces reserves can also ‘improve an entity's credit rating, as measured by rating agencies such as Standard & Poor's. Trading Center ‘The Federal Reserve has many tools ints monetary normalization toolkit. n addition to setting the fed funds rate, itrow has the ability to change the rate of interest that banks are paid on required (interest on reserves —IOR) and excess reserves (interest on excess reserves — IOER). New Laws, New Rules Increase Excess Reserves | Prior to Oct 1, 2008, banks were not pad arate of interest on reserves. The Financial Services, Regulatory Reliet Act of 206 authorized the Federal Reserve to pay banks arate of interest fr the first time. The rule was to go into effect on Oct 3, 2011; however, the Great Recession advanced the decision withthe Emergency Economic Stabilization Act of 2008, Suddenly, and forthe fist time in history, banks had an incentive to hold excess reserves atthe Federal Reserve. Excess eserves hita record $27 tillion in August 2014 due tothe quantitative easing program. In mid-June 2016, excess reserves stood at $2.3 trillon. Proceeds from quantitative easing were pald ‘outto banks by the Federal Reserve In the form of reserves, not cash. However, the interest pald on these reserves i pald out in cash and recorded as interest income forthe receiving bank. The Interest pald out to banks from the Federal Reserve is cash that would otherwise be going to the U.S. Treasury. The IOER Is the Fed Funds Rate Historically, the fe funds rate isthe rate at which banks lend money to one anather ands often used asa benchmark for varlable rate loans. Goth the IOR and the IOER are determined by the Federal Reserve, specifically the Federal Open Market Committee (FOMC).As a result, banks now have an incentive to hold excess reserves, especially when market rates are below the fed funds rate. In this way, the rate on excess reserves now serves asa proxy fr the fed funds rate. The Federal Reserve alone has the power to change this rate, which increased to 0.596 on Dec. 17,2015, after nearly a decade of lower bound interest rates. hitp:Iwwuinvestopedia.comermsielexcess_reserves.asp 122oii0r2017 Excess Reserves mine data for actionable insights. Buy Now >> Reserve Requirements Reserve requirements are requirements regarding the amount of cash a bank must hod in reserve _against deposits made by customers. This money must be in the bank's vaults or atthe closest Federal Reserve bank. Set by the Fed's board of governors, reserve requirements are one of the three main tools of monetary policy — the other two tools are open market operations and the discount rate, BREAKING DOWN ‘Reserve Requirements’ Banks loan funds out to customers based ona fraction ofthe cash they actually have on hand, The government makes one requirement of them In exchange for this ability: keep a certain amount of deposits on hand to cover possible withdrawals. This amounts called the reserve requirement, and itis the rate that banks must keep in the reserve. The Federal Reserve's Board of Governors sets the requirement as well as the interest rate banks get paid on excess reserves. The Financal Services Regulatory Relief Act of 2006 gave the Federal Reserve the right to pay interest on excess reserves. ‘The effective date in which banks started getting paid interest was Oct. 1, 2008. This rate of interest is referred tos the interest rate on excess reserves and serves asa proxy fr the federal funds rate. Read More+ Seven cope crime # A BC DE FOG HOT J KLM NOP QRS TU V x ca ere sis oscar seh £ ©2017 Ivesaped LC llgsReened | TemsofUse | Pac Pley hitp:Iwwuinvestopedia.comermsiefexcess_reserves.asp 22