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WASHINGTON, D.C. — America’s Community Bankers urged Congress today to allow the Federal Reserve Board to pay interest on the sterile reserves that banks and thrifts are required to hold at the Federal Reserve Banks.

Testifying at a hearing of the House Banking Committee, ACB Board Member Manuel J. Mehos said ACB strongly supports H.R. 4209, the Bank Reserves Modernization Act, introduced by Rep. Sue Kelly (R-N.Y.). Mehos is also chairman, president and CEO, Coastal Banc, Houston.

"Passage will increase the quality and the level of service that banks are able to provide to their customers, and improve the ability and the efficiency of the Federal Reserve in the conduct of monetary policy," he said.

Banks are now required to maintain a 10 percent required reserve ratio on all transaction balances that exceed an indexed, aggregate level (currently the first $49.3 million in aggregate consumer and business transaction accounts is exempt). Mehos described the reserves as the equivalent of a tax in the form of a non-interest bearing loan to the government.

"Authorizing the Federal Reserve to pay interest on reserves will eliminate this tax, create greater efficiencies in the banking industry by allowing banks to earn a return on all their assets, and result in deposits being more fully invested back into communities," he said.

"Competitive market forces will result in most of the earnings that banks receive on reserves being passed along to bank customers through reduced costs for services and higher interest returns on deposit accounts," he added.

Mehos said ACB was aware of the Treasury Department’s concerns that the payment of interest on sterile reserves will reduce the transfer of surplus funds by the Federal Reserve to the federal treasury. "We believe that the loss of revenue would not be large over the longer run, if there is a loss at all," said Mehos.

He explained that receiving interest on reserves would allow banks to compete more effectively with non-depositories, drawing funds back into the banking system and into reservable accounts.

Mehos said ACB believes that the costs of paying interest on reserves could, over time, be substantially offset by higher levels of reserves at Federal Reserve Banks. These higher reserve levels, earning a higher portfolio yield than the interest payments made by the Fed on those reserves, could generate income to offset much of the cost of the interest paid on reserves, he said.

Mehos reported that reserve balances at Federal Reserve Banks have declined to less than $6 billion from $28 billion in 1993, costing the Fed more than $22 billion in earning assets. He said that "sweep" technologies have drained money from banks’ consumer and business transaction accounts, shifting the balances to money market investments.

Mehos said the two primary reasons for these shifts are the statutory prohibition on banks paying interest on business checking accounts, and the implicit costs of reserve requirements which are passed on to customers.

Mehos commended the committee for successfully moving H.R. 4067 through the House. That bill would repeal the ban on banks paying interest on business checking accounts.

Please refer to the linked testimony for additional information.