Interest on excess reserves

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Regulated commercial banks and other depositary institutions are generally required to hold minimum levels of deposits with their central bank, in relation to their liabilities or for other regulatory reasons.

These central bank deposits are known as 'reserves'.

In some cases, these deposits of the commercial banks with the central bank may be greater than the minimum level required by the regulations.

When the central bank pays interests on such deposits, this interest is known as 'interest on excess reserves'.

Payment of interest on excess balances means that banks are less likely to lend central bank deposits (reserves) among themselves (in 'interbank' or (US) 'federal funds' transactions) at rates below the rate paid on the excess.

Varying the interest rate on excess reserves, then, allows the central bank to influence short-term rates in the economy generally.

In the US the Federal Reserve introduced a policy, its 'IOR policy', of paying interest on monetary institutions deposits ('reserves') in October 2008 and both required and excess reserves are remunerated.

The Financial Services Regulatory Relief Act of 2006 authorised payment of interest on balances of or on behalf of depositary institutions beginning October 1, 2011 but the Emergency Economic Stabilization Act of 2008 accelerated the effective date to October 1, 2008.

See also