Financial Update (April-June 1998)

Lagged Reserve Requirements
to Be Implemented in July

T he Federal Reserve Board voted to change the Fed's Regulation D, Reserve Requirements for Depository Institutions, from the current system of contemporaneous reserve requirements for institutions that are weekly deposit reporters to a system under which reserves are maintained on a lagged basis. Weekly deposit reporters generally include banks with $75 million or more in deposits.

Under the current contemporaneous reserve requirement system, the two-week maintenance, or reporting, period begins only two days after the beginning of a two-week reserve computation period. In contrast, under the lagged system that will go into effect July 30, 1998, the reserve maintenance period for weekly reporting institutions will begin 30 days (or two full maintenance periods) after the beginning (17 days after the end) of the reserve computation period. The proposal also allows the same two-period lag in the computations of vault cash to be applied to satisfy reserve requirements.

Improved Ability to Estimate Required Reserves

The two-period lag for both reserve requirements and applied vault cash allows the Federal Reserve and depository institutions to calculate the level of required reserve balances before the beginning of the maintenance period. Largely because of the implementation of retail sweep programs (used in recent years by numerous institutions to sweep funds from reservable transaction accounts to nonreservable savings accounts), it has become increasingly difficult to estimate the quantity of balances that depositories must hold at Reserve Banks to meet reserve requirements in the concurrent maintenance period. Increased lag time should make it easier for depository institutions and the Federal Reserve to estimate and project required reserve balances and enable them to reduce the level of resources devoted to these tasks. The change will also allow depository institutions to more accurately manage their reserve positions.

Open Market Operations Prosper From Change

The majority of the comments on the proposed changes to Regulation D received by the Board during the comment period supported the change in reserve requirement maintenance. In fact, four Reserve Banks and several depository institutions and industry associations commented that the change to a lagged reserve requirement would provide earlier, more accurate information about the level of required reserves. The Board expects more accurate information about required reserve balances to facilitate the implementation of monetary policy by the Fed's Open Market Desk. The Open Market Desk operating procedures favor a lagged reserve requirement.

Some Reserve Banks and institutions opposed the Regulation D change. Several Reserve Banks argued that the lagged reserve reporting system would make it more difficult to return to a regime of monetary targeting by the Fed. The Board, however, noted that there appears to be only a remote chance that the Federal Open Market Committee would move away from its current eclectic policymaking, involving a review of a wide variety of macroeconomic indicators, in order to return to a regime of strict monetary targeting.

The Regulation D change will become effective with the reserve maintenance period beginning July 30. For that maintenance period, required reserves and the vault cash that can be used to meet reserve requirements will be based on the computation period that begins on June 30.

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