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Thursday, March 02, 2006

Regulatory Relief for Banking Organizations

Today, Federal Reserve Governor Donald Kohn testified before the Committee on Banking, Housing, and Urban Affairs in the Senate on regulatory relief proposals for banking organizations the Fed would like to see implemented. Here are four of the thirty six proposals: 

Appendix: Regulatory Relief, Proposals Supported by the Board of Governors of the Federal Reserve System, Testimony of Donald Kohn: The Board believes the first 20 items listed below would provide meaningful regulatory relief to banking organizations within the jurisdiction of the Federal Reserve. The remaining 16 items would improve the supervision of banking organizations, facilitate the resolution of failed banks, streamline procedural or other requirements under the federal banking laws, or eliminate outdated provisions of law.

  1. Authorize the Federal Reserve to pay interest on balances held at Reserve Banks ...gives the Federal Reserve explicit authority to pay interest on balances held by depository institutions at the Federal Reserve Banks....
  2. Authorize depository institutions to pay interest on demand deposits ...repeals the provisions in current law that prohibit depository institutions from paying interest on demand deposits. If adopted, the amendment would allow all depository institutions that have the authority to offer demand deposits to pay interest on those deposits.
  3. Ease restrictions on interstate branching and mergers in a competitively equitable manner ...authorizes national and state banks to open de novo branches on an interstate basis. Currently, banks may establish de novo branches in a new state only if the state has affirmatively authorized de novo branching. This existing limitation places banks at a disadvantage to federal savings associations ...
  4. Allow insured banks to engage in interstate merger transactions with savings associations and trust companies ...would allow an insured bank to directly acquire, by merger, an insured savings association or uninsured trust company in a different home state without first converting ... into an insured bank. As under current law, the insured bank would have to be the survivor of the merger.

For me, an interesting feature of this is the following:

Having the authority to pay interest on excess reserves also could help mitigate potential volatility in overnight interest rates. If the Federal Reserve was authorized to pay interest on excess reserves, and did so, the rate paid would act as a minimum for overnight interest rates, because banks generally would not lend to other banks at a lower rate than they could earn by keeping their excess funds at a Reserve Bank. Although the Board sees no need to pay interest on excess reserves in the near future, the ability to do so would be a potentially useful addition to the monetary policy toolkit of the Federal Reserve.

The discussion, discussed previously here, brings up the possibility of a "channel" or "corridor" system for setting the federal funds rate as is currently in place in Canada, Australia, and New Zealand. This system makes open market operations unnecessary and allows the Fed, as proposed elsewhere on the proposed list or regulatory changes, to remove reserve requirements.

Currently, the federal funds rate is capped by the discount rate. Since the Fed will lend to banks at the discount rate, no bank would pay a higher rate in the federal funds market so the federal funds rate cannot go any higher than the discount rate. Similarly, with the ability to pay interest on deposits, no bank would lend to another bank at less than the rate the Fed will pay on deposits, so the federal funds rate cannot be lower than this. These two bounds are shown in the figure below (copied from Mishkin's text). Notice that if these bounds are fairly tight, the federal funds rate will be controlled precisely (for more on this point, see Woodford).  In addition, keeping the federal funds rate on target does not require open market operations, only discount window (lombard facility) borrowing and lending.

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    Posted by on Thursday, March 2, 2006 at 12:18 AM in Economics, Financial System, Regulation | Permalink  TrackBack (1)  Comments (16)


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