McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Transcription

1 Bank Reserves Management

2 Legal Reserves Legal Reserves Those assets that law and central bank regulation say must be held during a particular time period The current system of accounting for legal reserves is called lagged reserve accounting (LRA) The daily average amount of deposits and other reservable liabilities are computed using information gathered over a twoweek period stretching from a Tuesday through a Monday two weeks later This interval of time is known as the reserve computation period The daily average amount of vault cash each depository institution holds is also figured over the same two-week computation period

3 Federal Reserve Rules for Calculating a Weekly Reporting Depository Institution s Required Legal Reserves

4 Legal Reserves Management (continued) Legal Reserves Only two kinds of assets can be used for this purpose 1. Cash in the vault 2. Deposits held in a reserve account with the regional Fed Start 01/21/2016, the reserve requirement is 3 percent of the end-of-theday daily average amount held over a two-week period, from $15.2 million up to $110.2 million The first $15.2 million have zero legal reserves The $110.2 million figure is known as the reserve tranche and changes every year based on deposit growth Transaction deposits over $110.2 million held by the same depository institution carried a 10 percent legal reserve requirement This annual legal reserve adjustment is designed to offset inflation

5 Legal Reserves Management (continued) Calculating Required Reserves The largest depository institutions must hold the largest percentage of legal reserves Each reservable liability item is multiplied by the stipulated reserve requirement percentage to derive each depository s total legal reserve requirement

6 Legal Reserves Management (continued) Clearing Balances In addition to holding a legal reserve account at the central bank, many depository institutions also hold a clearing balance with the Fed to cover any checks or other debit items drawn against them For example, suppose a bank had a clearing balance averaging $1 million during a particular two-week maintenance period and the Federal funds interest rate over this same period averaged 5.50 percent Then it would earn a Federal Reserve credit of Assuming a 360-day year for ease of computation, this bank could apply up to $2, to offset any fees charged to the bank for its use of Federal Reserve services

7 Legal Reserves Management (continued) Sweep Accounts Volume of legal reserves held at the Fed has declined in recent years largely due to sweep accounts A contractual account between a bank and a customer that permits the bank to move funds out of a customer s checking account overnight in order to generate higher returns for the customer and lower reserve requirements for the bank Retail Sweep Business Sweep The sweeps market is likely to change in form and importance due to the recent passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2009

8 Legal Reserves Management (continued) Other Factors to Influence Legal Reserves Use of Fed Funds Market The cheapest source But very volatile Managers rely on the Fed funds target rate (the most volatile on the settlement date) Other Options Sell liquid securities Draw upon excess correspondent balances Enter into repurchase agreements for temporary borrowings Sell new time deposits Borrow in the Eurocurrency market

9 Central Bank Reserve Requirements around the Globe Not all central banks impose legal reserve requirements on the depository institutions they regulate For example, the Bank of England has not established official reserve requirements for its banks There is a trend among central banks around the globe to eliminate, suspend, or at least make less use of the reserve requirement tool, in part because it is so difficult to control A notable exception is the European Central Bank (ECB) Even if central banks imposed no reserve requirements, managers of depository institutions would still have a demand for cash reserves All depository institutions at one time or another need immediately available funds to handle customer withdrawals, meet new loan demand, and satisfy other emergency cash needs

10 Example: City Bank has estimated that its average daily demand deposit balance over the recent 14-day computation period was $225 million. The average daily balance with the Fed over the 14-day maintenance period was $11 million, and the average daily balance of vault cash over the two-week computation period was $7 million. Questions: a) Under the rules effective in 2016, what amount of average daily reserves is required to be held during the reserve maintenance period for these demand deposit balances? b) What is the average daily balance of reserves held by the bank over the maintenance period? By what amount were the average reserves held higher or lower than the required reserves? c) If the bank had transferred $20 million of its deposits every Friday over the two-week computation period to one of its off-shore facilities, what would be the revised average daily reserve requirement?