November 5 2008
The Federal Reserve, still battling a severe credit crisis, announced on Wednesday it will pay a higher interest rate to commercial banks on their reserves.
The Fed said it was altering the formulas it was using both for reserves the banks are required to keep on deposit at the Fed, and on excess reserves that banks choose to leave at the Fed.
The changes will provide slightly higher returns to banks for these funds, providing a boost to their earnings.
It marked the second time in just two weeks that the central bank has altered its interest rate formula to boost the interest it will pay banks.
Under the change, the Fed said it would pay an interest rate equal to the average target for the federal funds rate over a two-week maintenance period for reserves that banks are required to keep with the Fed.
Previously, the central bank had paid a rate that was 10 basis points below the funds rate target. A basis point is one-hundredth of a percentage point.
The Fed last week cut its target for the funds rate, the interest that banks charge each other for overnight loans, to 1 percent, tying a low seen only once before in the past half-century. It marked the latest in a series of aggressive efforts to combat a severe financial crisis that is threatening to push the country into a deep recession.
For excess reserves, the Fed said it will now pay the lowest average target for the funds rate over a two-week maintenance period. Previously, the amount paid on excess reserves left at the Fed was 35 basis points below the funds rate.
In announcing the higher rates to be paid to banks, the central bank said policy-makers had “judged that these changes would help foster trading in the funds market at rates closer to the … target federal funds rate.”
Congress in the $700 billion bailout package that passed on Oct. 3 gave the Fed the power to start paying banks interest on reserves and excess reserves.