A rumour that spread through the market yesterday was that Bernanke — who is due to testify today in front of Congress starting at 2:00 PM — would soon lower or eliminate the interest paid on excess reserves held at the Fed.The idea: Make it a little less lucrative to park cash and not loan it.
There’s a good chance the idea is bunk, but what if it were true?
Mike O’Rourke at BTIG examines the question.
The potential benefit of lowering the IOER rate is that of not only another interest rate easing, but more importantly, it would be intended to serve as a catalyst to prompt additional bank lending. Banks still have over $1 Trillion in Excess Reserves (Chart 1) from the Fed’s Quantitative Easing program parked in the safety of the Fed’s coffers. Year over year M2 ( growth has been running under 2%, which is muted for a nation that has recently completed 15 months of Quantitative Easing. Reducing the interest on reserves to zero theoretically would incentivise banks to lend or invest those reserves. Thus getting that money into the economy would stimulate activity and would appear as new M2 growth. It is the typical policy of trying to provide a nudge towards risk taking in a risk averse world. Currently, interest on excess reserves is 25 basis points, so the banks get the benefit of the yield of a 1 Year T-Bill for overnight parking. In an uncertain world, that’s not a bad deal if you happen to have an extra Trillion dollars sitting around.
Here’s the problem with the maths.
That being said, banks are only making $2.5 Billion per year from that interest. They could make the same amount by lending out $65 Billion (6% of those reserves) at 4%. Evidently they are opting for the conservative route. We would note that the weak response by the market to the revenue numbers at the banks will likely send the message to bank executives that they will need to pick up the pace of lending before the year ends, so a nudge from the Fed may not even be necessary. Regardless, having a lever to pull if necessary is a good thing.