Retail Sweep Programs and Bank Reserves, 1994-1999

Article excerpt

In January 1994, the Federal Reserve Board permitted a commercial bank to begin using a new type of computer software that dynamically reclassifies balances in its customer accounts from transaction deposits to a type of personal-saving deposit, the money market deposit account (MMDA). [1] This reclassification reduces the bank's statutory required reserves while leaving unchanged its customers' perceived holdings of transaction deposits.

The use of deposit-sweeping software spread slowly between January 1994 and April 1995, but rapidly thereafter. Estimates of the amounts of transaction deposits reclassified as MMDAs at all U.S. depository institutions, prepared by the Board of Governors' staff, are shown in Figure 1. [2] By late 1999, the amount was approximately $372 billion. In contrast, the aggregate amount of transaction deposits (demand plus other checkable deposits) in the published M1 monetary aggregate, as of December 1999, was $599.2 billion.

In this analysis, we interpret the effects of deposit-sweeping software on bank balance sheets to be economically equivalent to a reduction in statutory reserve-requirement ratios. We seek to measure the amount by which such deposit-sweeping activity has reduced bank reserves (vault cash and deposits at Federal Reserve Banks). Currently, transaction deposits are subject to a 10 percent statutory reserve-requirement ratio on amounts over the low-reserve tranche ($44.3 million during 2000, $42.8 million during 2001), whereas personal-saving accounts, including MMDAs, are subject to a zero ratio. [3]

To be useful in policy analysis and empirical studies, aggregate quantity data on bank reserves must be adjusted for the effects of changes in statutory reserve requirements on the quantity of reserves held by banks. [4] In the past, such adjustments were straightforward because changes in statutory reserve requirements applied simultaneously and uniformly to groups of depository institutions within only a small number of broad classes. The effective date for changes in statutory requirements varied slightly among depositories that report data to the Federal Reserve weekly (larger banks), those that report quarterly (smaller banks), and those that report annually (very small banks). Within each group, however, the effective date was the same for all institutions. During the 1980s, the only changes in statutory requirements were due to the phase-in and indexation provisions of the Monetary Control Act. During the 1990s, the reserve-requirement ratio applicable to nonpersonal savings and time deposits was redu ced from 3 percent to zero (December 1990) and the highest marginal ratio applicable to transaction deposits was reduced from 12 percent to 10 percent (April 1992). [5]

The economic effect of deposit-sweeping software is unlike these previous changes. The essence of deposit-sweeping software is that it permits banks to change the share of their transaction deposits that are subject to a non-zero statutory reserve-requirement ratio (see the insert "How Deposit-sweeping Software Reduces Required Reserves"). Each bank is free to decide when and how to implement the software, subject to constraints discussed below. In this way, in part, banks' effective reserve requirements are "home brewed." As a result, the economic effects of deposit-sweeping software must be analyzed and measured bank-by-bank.

Our analysis suggests that required and total reserves in December 1999, measured by the reserve adjustment magnitude (RAM) developed in this article, were lower by $34.1 billion and $25.8 billion, respectively, as a result of deposit-sweeping activity. In addition, many depository institutions have reduced their required reserves to such an extent that the lower requirement places no constraint on the bank because it is less than the amount of reserves (vault cash and deposits at the Federal Reserve) that the bank requires for its ordinary day-to-day business. …