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New Fed rate on excess reserve balances
WASHINGTON (10/24/08)—Effective yesterday, the Federal Reserve Board adopted a revised formula to determine the interest rate it will pay on credit unions' and other depository institutions' excess reserve balances. The Fed determined that a narrower spread between the target funds rate and the rate on excess balances would help encourage trading in the funds market at rates closer to the target rate. Therefore, the Fed issued a new formula that sets the rate on excess balances equal to the lowest Federal Open Market Committee (FOMC) target rate in effect during the reserve maintenance period less 35 basis points. Prior to the change, the rate had been set as the lowest federal funds rate target established by the FOMC in effect during the reserve maintenance period minus 75 basis points. The Fed announced just two weeks ago that it would begin to pay interest on depository institutions' required and excess reserve balances effective Oct. 9. The Financial Services Regulatory Relief Act of 2006 gave the Fed authority starting in 2011 to lower reserves to zero and/or to pay interest--not to exceed other short-term rates--on the reserve balances actually maintained. The new Emergency Economic Stabilization Act gave the Fed that authority starting now. The authority is being implemented through changes to the Fed's Regulation D. Reserve balances are balances held to satisfy depository institutions' reserve requirements and excess balances are those held in excess of required reserving balances and clearing balances.


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