[House Report 106-983]
[From the U.S. Government Publishing Office]



106th Congress                                                   Report
                        HOUSE OF REPRESENTATIVES
 2d Session                                                     106-983

======================================================================



 
                BANK RESERVES MODERNIZATION ACT OF 2000

                                _______
                                

October 17, 2000.--Committed to the Committee of the Whole House on the 
              State of the Union and ordered to be printed

                                _______
                                

   Mr. Leach, from the Committee on Banking and Financial Services, 
                        submitted the following

                              R E P O R T

                        [To accompany H.R. 4209]

      [Including cost estimate of the Congressional Budget Office]

  The Committee on Banking and Financial Services, to whom was 
referred the bill (H.R. 4209) to amend the Federal Reserve Act 
to require the payment of interest on reserves maintained at 
Federal reserve banks by insured depository institutions, and 
for other purposes, having considered the same, report 
favorably thereon with amendments and recommend that the bill 
as amended do pass.
  The amendments are as follows:
  Strike out all after the enacting clause and insert in lieu 
thereof the following:

SECTION 1. SHORT TITLE.

  This Act may be cited as the ``Bank Reserves Modernization Act of 
2000''.

SEC. 2. PAYMENT OF INTEREST ON RESERVES AT FEDERAL RESERVE BANKS.

  (a) In General.--Section 19(b) of the Federal Reserve Act (12 U.S.C. 
461(b)) is amended by adding at the end the following new paragraph:
          ``(12) Earnings on reserves.--
                  ``(A) In general.--Balances maintained at a Federal 
                reserve bank by or on behalf of a depository 
                institution may receive earnings to be paid by the 
                Federal reserve bank at least once each calendar 
                quarter at a rate or rates not to exceed the general 
                level of short-term interest rates.
                  ``(B) Regulations relating to payments and 
                distribution.--The Board may prescribe regulations 
                concerning--
                          ``(i) the payment of earnings in accordance 
                        with this paragraph;
                          ``(ii) the distribution of such earnings to 
                        the depository institutions which maintain 
                        balances at such banks or on whose behalf such 
                        balances are maintained; and
                          ``(iii) the responsibilities of depository 
                        institutions, Federal home loan banks, and the 
                        National Credit Union Administration Central 
                        Liquidity Facility with respect to the 
                        crediting and distribution of earnings 
                        attributable to balances maintained, in 
                        accordance with subsection (c)(1)(B), in a 
                        Federal reserve bank by any such entity on 
                        behalf of depository institutions.''.
  (b) Authorization for Pass Through Reserves for Member Banks.--
Section 19(c)(1)(B) of the Federal Reserve Act (12 U.S.C. 461(c)(1)(B)) 
is amended by striking ``which is not a member bank''.
  (c) Technical and Conforming Amendments.--Section 19 of the Federal 
Reserve Act (12 U.S.C. 461) is amended--
          (1) in subsection (b)(4) (12 U.S.C. 461(b)(4)), by striking 
        subparagraph (C) and redesignating subparagraphs (D) and (E) as 
        subparagraphs (C) and (D), respectively; and
          (2) in subsection (c)(1)(A) (12 U.S.C. 461(c)(1)(A)), by 
        striking ``subsection (b)(4)(C)'' and inserting ``subsection 
        (b)''.

SEC. 3. TRANSFER OF FEDERAL RESERVE SURPLUSES.

  (a) In General.--Section 7(b) of the Federal Reserve Act (12 U.S.C. 
290) is amended by adding at the end the following new paragraph:
          ``(4) Additional transfers to cover interest payments for 
        fiscal years 2001 through 2005.--
                  ``(A) In general.--In addition to the amounts 
                required to be transferred from the surplus funds of 
                the Federal reserve banks pursuant to paragraph (1), 
                the Federal reserve banks shall transfer from such 
                surplus funds to the Board of Governors of the Federal 
                Reserve System for transfer to the Secretary of the 
                Treasury for deposit in the general fund of the 
                Treasury, such sums as are necessary to equal the net 
                cost of section 19(b)(12), as estimated by the Office 
                of Management and Budget, in each of the fiscal years 
                2001 through 2005.
                  ``(B) Allocation by federal reserve board.--Of the 
                total amount required to be paid by the Federal reserve 
                banks under subparagraph (A) for fiscal years 2001 
                through 2005, the Board of Governors of the Federal 
                Reserve System shall determine the amount each such 
                bank shall pay in such fiscal year.
                  ``(C) Replenishment of surplus fund prohibited.--
                During fiscal years 2001 through 2005, no Federal 
                reserve bank may replenish such bank's surplus fund by 
                the amount of any transfer by such bank under 
                subparagraph (A).''.
  (b) Technical and Conforming Amendment.--Section 7(a) of the Federal 
Reserve Act (12 U.S.C. 289(a)) is amended by adding at the end the 
following new paragraph:
          ``(3) Payment to treasury.--During fiscal years 2001 through 
        2005, any amount in the surplus fund of any Federal reserve 
        bank in excess of the amount equal to 3 percent of the paid-in 
        capital and surplus of the member banks of such bank shall be 
        transferred to the Secretary of the Treasury for deposit in the 
        general fund of the Treasury.''.

  Amend the title so as to read:

      A bill to amend the Federal Reserve Act to authorize the 
payment of interest on reserves maintained at Federal reserve 
banks by insured depository institutions, and for other 
purposes.

                  Background and Need for Legislation

    During the past ten years, there has been a significant 
decline in the amount of required reserves held by depository 
institutions at the Federal Reserve Banks. In late 1993, 
reserve balances were approximately $28 billion whereas, today, 
they are about $6 billion. While the Federal Reserve Act 
requires depository institutions, including all banks, thrifts, 
and credit unions, to maintain reserves against their 
transactions accounts, many institutions have been able to 
reduce the amount of funds they must hold in their reserve 
accounts through the use of ``sweep'' programs that permit 
funds to be transferred out of reservable transaction accounts 
(e.g. checking accounts) into nonreservable instruments (e.g. 
money market deposit accounts) at the end of each day. A strong 
incentive for the development and use of these sweep programs 
has been and continues to be the fact that depository 
institutions do not receive interest on the reserves they are 
required to hold at the Federal Reserve Banks.
    For most depository institutions, required reserves are 
calculated based on an average of the applicable deposits held 
by a depository institution over a two-week computation period. 
The first $5 million in applicable deposits is not included in 
the calculation. Smaller financial institutions in particular 
benefit from this exemption. The Federal Reserve assesses a 
ratio of 3% to applicable deposits held by an institution 
between $5 million and $44 million. The current ratio for 
applicable deposits over $44 million is 10%. The Federal 
Reserve has discretion to change the first tier between 3% and 
9%, and the second tier within the range of 8% and 14%. The 
Federal Reserve currently does not require any reserves for 
nonpersonal time and savings accounts, although the percentage 
required to be held as reserves could range from 0% to 3%. 
Similarly, the Federal Reserve requires no reserves to be held 
for Eurocurrency liabilities although it has the discretion to 
do so.
    The decline in the amount of reserves potentially presents 
an important policy question because the sole purpose for 
requiring reserves, as reflected in the Federal Reserve Act, is 
to provide a tool for the implementation of monetary policy. 
While the Federal Reserve Board has stated that the decline in 
reserves held by Federal Reserve banks during the past decade 
has not yet affected its ability to effectively conduct 
monetary policy, it believes volatility could mount in the 
future and cause potentially disruptive fluctuations in the 
money market. The Federal Reserve has stated that reserve 
requirements continue to play an important role in the conduct 
of open market operations, which are aimed at influencing 
general monetary and credit conditions by varying the cost and 
availability of reserves to the banking system. Reserve 
requirements help to ensure a stable, predictable demand for 
reserves, and therefore the Federal Reserve is better able to 
achieve stable short-term interest rates by controlling the 
supply of reserves through transactions with financial 
institutions.

                          Purpose and Summary

    The purpose of H.R. 4209 is to authorize the Federal 
Reserve Board to pay interest on the reserves that depository 
institutions maintain at Federal Reserve Banks. Currently, 
depository institutions that maintain deposits on reserve at 
Federal Reserve Banks do not receive any interest on their 
deposits. Due to the constraint imposed on depository 
institutions in their ability to earn a return on assets, 
depository institutions have undertaken considerable effort in 
recent years to find methods to reduce their reserve 
requirements and have thus undercut this key monetary policy 
tool. Payment of interest on reserves provides a way of 
removing an incentive for depository institutions to avoid the 
reserve requirements and eliminating an inefficiency in the 
regulatory system that could have a negative effect on smaller 
institutions who are unable to take advantage of mechanisms to 
avoid reserve requirements.

                                Hearings

    The full Committee heard testimony on H.R. 4209 on May 3, 
2000. Witnesses at the hearing were: Gary Gentler, Under 
Secretary for Domestic Finance, the Department of the Treasury; 
Laurence H. Meyer, Member, Board of Governors of the Federal 
Reserve System; Thomas P. Jennings, Senior Vice President and 
General Counsel, First Virginia Banks, Inc. on behalf of 
Financial Services Roundtable; Carl R. Tannenbaum, Senior Vice 
President and Chief Economist for Treasury Research, LaSalle 
Banks, Chicago, IL, on behalf of American Bankers Association; 
Manuel Mehos, Chairman, President and CEO, Coastal Banc, 
Houston TX, on behalf of America's Community Bankers; and A. 
Pierce Stone, President and CEO, Virginia Community Bank, 
Louisa, VA on behalf of Independent Community Bankers of 
America.
    The Subcommittee on Financial Institutions and Consumer 
Credit also had hearings on this issue as part of regulatory 
relief issues. On May 12, 1999, the Subcommittee heard 
testimony on H.R. 1585, Depository Institution Regulatory 
Streamlining Act of 1999, which included a provision regarding 
payment of interest on reserves. Witnesses at the hearing 
included: Laurence H. Meyer, Member, Board of Governors of the 
Federal Reserve System; John D. Hawke, Jr., Comptroller of the 
Currency, Office of the Comptroller of the Currency; Andrew 
Hove, Vice Chairman, Federal Deposit Insurance Corporation; 
Carolyn Buck, Chief Counsel, Office of Thrift Supervision; 
Robert Fenner, General Counsel, National Credit Union 
Administration; John P. Burke, Chairman, Conference of State 
Bank Supervisors, and Banking Commissioner, State of 
Connecticut; Edward L. Yingling, Executive Director of 
Government Relations, American Bankers Association; Robert N. 
Barsness, Chairman and President, Prior Lake State Bank, Prior 
Lake, Minnesota, and President, Independent Community Bankers 
of America; David R. Taylor, President and CEO, Rahway Savings 
Institution, Rahway, New Jersey, and on behalf of America's 
Community Bankers; Frank Torres, Legislative Counsel, Consumers 
Union; Margot Saunders, Managing Attorney, National Consumer 
Law Center, Inc.; and Jean N. Fox, Director of Consumer 
Protection, Consumer Federation of America Foundation.
    In the 105th Congress, the Subcommittee on Financial 
Institutions and Consumer Credit reviewed payment of interest 
on reserves as part of a regulatory burden relief hearing on 
July 16, 1998. Testifying at the hearing were: The Honorable 
Sue Kelly; the Honorable Bill McCollum; The Honorable Jack 
Metcalf; Richard S. Carnell, Assistant Secretary for Financial 
Institutions, Department of the Treasury; Laurence H. Meyor, 
Member, Board of Governors of the Federal Reserve System; Donna 
Tanoue, Chairman, Federal Deposit Insurance Corporation; Julie 
Williams, Acting Comptroller, Office of the Comptroller of the 
Currency; Carolyn Buck, Chief Counsel, Office of Thrift 
Supervision; Timothy R. McTaggart, Bank Commissioner, State of 
Delaware, on behalf of the Conference of State Bank 
Supervisors; James E. Smith, President and CEO, Union State 
Bank and Trust, Clinton, MO, on behalf of the American Bankers 
Association; Anthony S. Abbate, President and CEO, Interchange 
Bank, Saddle Brook, NJ, on behalf of the Independent Bankers 
Association of America; Lee E. Beard, President and CEO, First 
Federal Bank, Hazelton, PA, on behalf of America's Community 
Bankers; Arthur R. Cunningham, CCM, CPA, Senior Assistant 
Treasurer, Pioneer Hi-Bred International, Inc., Johnston, IA, 
on behalf of the Treasury Management Association; Rex Hammock, 
Chairman, Hammock Publishing, Inc., Nashville, TN, on behalf of 
the National Federation of Independent Business; and Margot 
Saunders, Managing Attorney, National Consumer Law Center, also 
on behalf of the U.S. Public Interest Research Group.

                   Committee Consideration and Votes

    On May 17, 2000, the Committee met in open session to mark 
up H.R. 4209, the ``Bank Reserves Modernization Act.'' During 
the markup, the Committee approved, by voice vote, an amendment 
to H.R. 4209. With a quorum being present, a motion to adopt 
and favorably report H.R. 4209, as amended, to the House was 
approved by voice vote.

                      Committee Oversight Findings

    In compliance with clause 3(c)(1) of rule XIII of the Rules 
of the House of Representatives, the Committee reports that the 
findings and recommendations of the Committee, based on 
oversight activities under clause 2(b)(1) of rule X of the 
Rules of the House of Representatives, are incorporated in the 
descriptive portions of this report.

         Committee on Government Reform and Oversight Findings

    As provided for in clause 3(c)(4) of rule XIII of the Rules 
of the House of Representatives, no oversight findings have 
been submitted to the Committee by the Committee on Government 
Reform.

                        Constitutional Authority

    In compliance with clause 3(d)(1) of rule XIII of the Rules 
of the House of Representatives, the Constitutional Authority 
of Congress to enact this legislation derived from Article I, 
section 8, clause 1 (relating to the general welfare of the 
United States): Article I, section 8, clause 3 (relating to 
Congressional power to regulate commerce); Article 1, section 
8, clause 5 (relating to the power ``to coin money'' and 
``regulate the value thereof''); and Article I, section 8, 
clause 18 (relating to making all laws necessary and proper for 
carrying into execution powers vested by the Constitution in 
the government of the United States).

               New Budget Authority and Tax Expenditures

    In compliance with clause 3(c)(2) of rule XIII of the Rules 
of the House of Representatives, and as noted in the enclosed 
CBO estimate, H.R. 4209 would not have any net effect on annual 
revenues over the 2001-2005 period.

                      Advisory Committee Statement

    No advisory committees within the meaning of section 5(b) 
of the Federal Advisory Committee Act were created by this 
legislation.

                    Congressional Accountability Act

    The reporting requirement under section 102(b)(3) of the 
Congressional Accountability Act (P.L. 104-1) is inapplicable 
because this legislation does not relate to terms and 
conditions of employment or access to public services or 
accommodations.

    Congressional Budget Office Cost Estimate and Unfunded Mandates 
                                Analysis

                                     U.S. Congress,
                               Congressional Budget Office,
                                   Washington, DC, October 6, 2000.
Hon. James A. Leach,
Chairman, Committee on Banking and Financial Services, House of 
        Representatives, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for the Bank Reserves 
Modernization Act of 2000.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contacts are Carolyn 
Lynch (for revenues), and Patrice Gordon (for the private-
sector impact).
            Sincerely,
                                          Dan L. Crippen, Director.
    Enclosure.

H.R. 4209--Bank Reserves Modernization Act of 2000

    Summary: H.R. 4209, the Bank Reserves Modernization Act of 
2000 (BRMA), would permit the Federal Reserve System to pay 
interest on reserves held on deposit at the Federal Reserve by 
insured depository institutions. The reduction in revenues as a 
result of the interest payments would be offset by transfers 
from surplus funds of Federal Reserve Banks to the U.S. 
Treasury over the next five years. Pay-as-you-go procedures 
would apply because the bill would affect receipts. CBO 
estimates that the bill would not have any net effect on annual 
revenues over the 2001-2005 period because the estimated loss 
in revenues would be offset by transfers from Federal Reserve 
surplus funds. Enacting H.R. 4209 would decrease revenues after 
2005. CBO estimates that the loss in revenues would total 
approximately $1.1 billion over the 2006-2010 period.
    H.R. 4209 contains no intergovernmental or private-sector 
mandates as defined in the Unfunded Mandates Reform Act (UMRA) 
and would not affect the budgets of state, local, or tribal 
governments.
    Estimated cost to the Federal Government: The estimated 
budgetary impact of H.R. 4209 is shown in the following table.

----------------------------------------------------------------------------------------------------------------
                                                          By fiscal year, in millions of dollars--
                                           ---------------------------------------------------------------------
                                              2001      2002      2003      2004      2005     2001-05   2006-10
----------------------------------------------------------------------------------------------------------------
                                               CHANGES IN REVENUES

Allowing Interest on Reserves.............      -189      -136       -88       -91       -96      -600      -548
Surplus Transfer to the Treasury..........       189       136        88        91        96       600      -600
                                           ---------------------------------------------------------------------
      Net Budgetary Effect................         0         0         0         0         0         0    -1,148
----------------------------------------------------------------------------------------------------------------

    The initial budgetary effect of BRMA would be a decrease in 
the payment of profits from the Federal Reserve System to the 
U.S. Treasury. The Federal Reserve remits its profits to the 
Treasury, and those payments are classified as governmental 
receipts, or revenues, in the federal budget. Any additional 
income or costs to the Federal Reserve, therefore, can affect 
the federal budget. The Federal Reserve's largest source of 
income is interest from its holdings of Treasury securities. In 
effect, the Federal Reserve invests in Treasury securities the 
reserve balances and issues of currency that comprise the bulk 
of its liabilities. Since the Federal Reserve pays no interest 
on reserves or currency, and the Treasury pays the Federal 
Reserve interest on its security holdings, the Federal Reserve 
earns profits.
    By allowing the Federal Reserve to pay interest on 
reserves, the bill, according to CBO's analysis, would decrease 
the Federal Reserve's profits and thereby reduce federal 
revenues by $600 million over the period from 2001 to 2005. 
This budgetary response has several components. First, the 
Federal Reserve's payment of interest on required reserves 
balances held at Federal Reserve banks would reduce 
governmental receipts. It is anticipated that some depository 
institutions and depositors would respond to the interest 
payments on reserves by shifting funds out of retail sweep 
accounts and into demand deposit accounts. This secondary 
response would increase required reserve balances and partially 
offset the loss in federal revenues from the payment of 
interest on reserves. Finally, the profits of depository 
institutions or their customers would increase with a 
consequent increase in tax revenues. That result would also 
have the effect of partially offsetting the decline in federal 
receipts. The legislation stipulates that this overall revenue 
loss would be offset by a transfer from surplus funds of 
Federal Reserve banks to the U.S. Treasury for each of the 
fiscal years 2001 through 2005.
    Basis of estimate: The estimates assume that the provisions 
would become effective early in fiscal year 2001, unless 
otherwise specified.

The allowance of interest on reserve balances

    Allowing the payment of interest on the reserves that 
depository institutions hold on deposit at the Federal Reserve 
(``required and excess reserve balances'') would shift profits 
from the Federal Reserve to depository institutions and reduce 
governmental receipts. This budgetary effect is divided into 
three components. First, the bill would result in the Federal 
Reserve paying interest on the level of its required reserve 
balances expected under current law, reducing its net income 
and, therefore, governmental receipts. Second, the payment of 
interest on reserves is expected to cause demand balances at 
depository institutions to increase. That increase would raise 
the level of reserve balances held at the Federal Reserve, 
which would invest them at a higher rate than it would pay on 
them. This change in projected reserves would increase 
governmental receipts, but only partially offset the loss 
caused by the payment of interest on reserves projected under 
current law. Third, the reduction in governmental receipts 
would be partially offset by increased income tax receipts. The 
net effect of interest payments on reserves and the anticipated 
shift to more demand deposit accounts would result in higher 
profits for depository institutions or their customers.

----------------------------------------------------------------------------------------------------------------
                                             Allowing interest on reserve balances (by fiscal year, in millions
                                                                        of dollars)--
                                           ---------------------------------------------------------------------
                                              2001      2002      2003      2004      2005     2001-05   2006-10
----------------------------------------------------------------------------------------------------------------
                                               CHANGES IN REVENUES

Revenue from Federal Reserve:
    Interest on Required Reserves.........      -291      -234      -209      -219      -229    -1,182    -1,311
    Profits from Increased Reserves.......        39        53        92        97       101       382       580
                                           ---------------------------------------------------------------------
      Net Revenue Effect..................      -252      -181      -117      -122      -128      -800      -731
Income Tax Revenue........................        63        45        29        31        32       200       183
                                           ---------------------------------------------------------------------
      Allowing Interest on Reserves.......      -189      -136       -88       -91       -96      -600      -548
----------------------------------------------------------------------------------------------------------------

    Interest Payments on Reserves Projected Under Current Law. 
Because depository institutions currently do not earn a return 
on reserve balances, they have an incentive to minimize such 
balances. Required reserve balances measured almost $30 billion 
at the end of 1993, but have since fallen sharply to just under 
$7 billion today. The widely reported expansion of consumer and 
business sweep accounts have caused this decline. In typical 
sweep accounts, banks shift their depositor's funds from demand 
deposits, against which reserves are required, into other 
depository accounts, against which no reserves are required. 
The banks shift the funds back to the demand deposit accounts 
the next business day, or when needed by the depositor. Sweep 
accounts for business demand deposits have existed in various 
forms since the early 1970s. Recent advances in computer 
technology have now made the shifting of funds feasible for 
many consumer (``retail'') accounts as well. Under current law, 
CBO expects the expansion of retail sweep accounts to continue 
and required reserve balances to decline further to about $4 
billion by 2002. Thereafter, CBO projects them to rise 
gradually with growth in the economy.
    H.R. 4209 would permit the Federal Reserve to pay interest 
on required and excess reserve balances. The Federal Reserve 
would be allowed to choose the interest rate, although the rate 
chosen could not exceed the general level of short-term 
interest rates. Staff at the Federal Reserve, however, have 
indicated that, given the authority, the Federal Reserve would 
only pay interest on required reserve balances and it would 
choose an interest rate near the key short-term rate, the 
federal funds rate. The likely rate would be roughly 15 basis 
points lower than the federal funds rate to account for the 
lack of risk. Federal Reserve staff have indicated that the 
Federal Reserve would choose not to pay interest on excess 
reserves unless required reserve balances fell to such a low 
level that interest on excess reserves was needed to build 
reserves. That is considered to be an unlikely scenario. 
Accordingly, CBO assumes that the Federal Reserve would pay 
interest only on required reserves, at a rate 15 basis points 
below the federal funds rate.
    CBO projects that the federal funds rate will average about 
5.5 percent over the 10-year period from 2001 through 2010. The 
payment of interest on reserves is assumed to start early in 
fiscal year 2001. CBO projects that BRMA would cause the 
Federal Reserve to pay interest to depository institutions of 
about $291 million in 2001 on the $4.25 billion of required 
reserve balances expected under current law. Such interest 
payments would decline to about $234 million in 2002 and $209 
million in 2003 because of lower reserve balances. Over the 
2001-2005 period, such interest payments would total 
approximately $1.2 billion. Those payments would reduce the 
profits of the Federal Reserve--and thus its payment to the 
Treasury--by the same amount.
    Projected Impact of the Bill on the Volume of Reserves. If 
the Federal Reserve pays interest on required reserve balances, 
there would be a second budgetary effect on the Federal Reserve 
that would reduce--but not eliminate--the net revenue loss from 
the payment of interest. In particular, based on a survey by 
the Board of Governors of the Federal Reserve System, we would 
expect reserve balances to increase because depository 
institutions would close a significant share of their retail 
sweep accounts and, as a result, maintain a higher level of 
required reserves. By doing so, the institutions could 
eliminate the costs of maintaining the sweep accounts and 
receive a return on their required reserves, although 
presumably at a lower rate than what they could receive with 
alternative use of the funds. The closing of business sweep 
accounts, in general, is not expected because depository 
institutions are not allowed to offer interest-bearing demand 
deposits to businesses. As a result, businesses would have 
little incentive to relinquish their interest-bearing sweep 
accounts.
    CBO assumes that depository institutions would eliminate 
approximately 30 percent of retail sweep accounts currently in 
existence by 2002, and half of those that otherwise would be 
established. As a result of the closings of retail sweep 
accounts, demand deposits on which required reserves are 
calculated would increase at depository institutions. CBO 
projects that required reserve balances would increase above 
the level expected under current law by about $10 billion in 
2002 and $15 billion by 2005. Although the Federal Reserve 
would pay interest on the added reserves at approximately the 
federal funds rate, it would invest the reserves in Treasury 
securities, earning a rate of return in excess of the federal 
funds rate by an amount estimated at between 0.55 and 0.65 of a 
percentage point. As a result of the rate differential, the 
Federal Reserve would generate additional profits of about $382 
million through 2005 and remit them to the Treasury as 
governmental receipts.
    Projected Impact on Income Tax Revenues. Allowing interest 
on reserve balances held at the Federal Reserve would have a 
third budgetary effect that would also reduce--but not 
eliminate--the decline in revenue from the payment of interest 
on current balances. The net effect of interest payments on 
reserves and the anticipated shift to more demand deposit 
accounts is expected to be a reduction in the profits of the 
Federal Reserve and an increase in the profits of depository 
institutions or their customers, with a consequent increase in 
income tax revenues. CBO assumes that the profits of depository 
institutions or their customers would increase by roughly the 
same amount that the profits of the Federal Reserve decline. It 
is likely that, instead of retaining the additional interest 
income from the Federal Reserve, depository institutions would 
pass through some of the increased profits to their consumer 
and business customers by, for example, raising interest rates 
on deposits or lowering rates on loans. If a complete 
passthrough did occur, then the customers--not the depository 
institutions--would accrue the income and pay additional taxes. 
Although some of the additional interest income of depository 
institutions may be passed through in nontaxable form either to 
their customers or to nontaxable entities, this amount is 
expected to be negligible. CBO assumes that depository 
institutions and their customers face an average marginal tax 
rate on income of 25 percent and estimate that income tax 
receipts would increase by about $63 million in 2001 and 
approximately $200 million through 2005. That increase in 
receipts would offset one-quarter of the reduction in 
governmental receipts from reduced Federal Reserve profits.

Transfer from surplus funds of the Federal Reserve

    During the first five years BRMA would be effective (fiscal 
years 2001 through 2005), the legislation provides that the 
revenue loss associated with allowing interest payments on 
reserve balances would be offset by requiring the Federal 
Reserve to remit from its surplus fund to the Treasury an 
amount equal to the estimated annual net revenue loss. In 
addition, during this same five-year period, the bill would 
make the Federal Reserve payment of net earnings to the 
Treasury mandatory and the Federal Reserve would not be allowed 
to replenish its surplus fund. Those provisions would have the 
effect of reducing the cost of the legislation to zero for the 
first five years the bill is in effect and postpone the 
accumulated net revenue loss to the federal government to the 
sixth year, 2006.
    Out of its annual earnings, the Federal Reserve covers its 
operating costs, pays a small dividend to its member banks, 
retains monies for its surplus fund, and voluntarily remits the 
remaining profits to the U.S. Treasury. The Federal Reserve's 
surplus fund is a stock of retained earnings accumulated over 
time and is set by the Federal Reserve banks each year at a 
level equal to the paid-in capital of its member banks. The 
fund can be used as collateral for issuance of Federal Reserve 
notes and may be viewed as a fiscal cushion. The surplus funds 
are invested in Treasury securities and the interest generated 
is remitted to the Treasury along with other profits of the 
Federal Reserve. During the first five years BRMA is in effect, 
the Federal Reserve would remit to the Treasury all of its 
earnings above its operating costs and member bank dividend 
payments because the Federal Reserve would be prevented from 
replenishing its surplus fund and its payment of net earnings 
to the Treasury would be mandatory. In fiscal year 2006, 
however, the Federal Reserve would be expected to replenish its 
surplus fund by the entire amount that was transferred from the 
fund to the Treasury during the 2001-2005 period, an estimated 
$600 million. This response is anticipated because the Federal 
Reserve has replenished its surplus account at its first 
available opportunity with past legislated surplus fund 
transfer payments. The legislated surplus fund transfer under 
BRMA, therefore, has the effect of postponing the accumulated 
net revenue loss to the Treasury during the first five years 
the legislation is in effect until the sixth fiscal year, 2006. 
CBO estimates that the revenue loss in fiscal year 2006 would 
be about $700 million. The Federal Reserve would be expected to 
retain $600 million out of its earnings to replenish its 
surplus fund instead of remitting these profits to the 
Treasury. The remaining $100 million is the estimated net 
revenue loss of allowing interest payments on reserve balances 
for that year. CBO estimates that the resulting revenue loss 
for the 2006-2010 period would be approximately $1.1 billion.
    The analysis shows that the transfer of the surplus funds 
does not reduce the cost of the bill to the federal government 
over the long term, it just postpones it. It also is important 
to note that the transfer of surplus funds from the Federal 
Reserve to the Treasury has no import for the fiscal status of 
the Federal government either. If the surplus funds are held at 
the Federal Reserve, they are invested in government securities 
and the interest generated is remitted to the Treasury. If the 
surplus funds and transferred to the Treasury instead, they 
reduce the public debt and in turn the interest payments owed 
by the Treasury. Since the interest payments would be identical 
in either case, where the funds reside has no economic 
significance. Hence, any transfer of the Federal Reserve 
surplus fund to the Treasury would have no effect on national 
savings, economic growth, or income.
    Pay-as-you-go considerations: The Balanced Budget and 
Emergency Deficit Control Act sets up pay-as-you-go procedures 
for legislation affecting direct spending or receipts. CBO 
estimates that H.R. 4209 would not affect receipts over the 
2001-2005 period, but would reduce receipts by $1,148 million 
over the 2006-2010 period, as shown in the following table. For 
the purposes of enforcing pay-as-you-go procedures, only the 
effects in the budget year and the succeeding four years are 
counted.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                           By fiscal year, in millions of dollars--
                                                                    ------------------------------------------------------------------------------------
                                                                      2001    2002    2003    2004    2005     2006     2007     2008     2009     2010
--------------------------------------------------------------------------------------------------------------------------------------------------------
Changes in receipts................................................       0       0       0       0       0     -700     -105     -109     -114     -120
Changes in outlays.................................................                                     Not applicable
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Estimated impact on state, local, and tribal governments: 
H.R. 4209 contains no intergovernmental mandates as defined in 
UMRA and would not affect the budgets of state, local, or 
tribal governments.
    Estimated impact on the private sector: H.R. 4209 would 
require the Federal Reserve to pay interest on required reserve 
balances held on deposit at the Federal Reserve. The bill would 
also authorize the Board of Governors of the Federal Reserve 
System (FRB) to prescribe regulations concerning the 
responsibilities of correspondent banks that maintain balances 
at the Federal Reserve on behalf of other institutions. Such 
private institutions as commercial banks, Federal Home Loan 
Banks, and Corporate Credit Unions serve as correspondent banks 
for many depository institutions that are not members of the 
Federal Reserve. Based on information provided by the FRB, CBO 
expects the FRB would not use its authority to issue 
regulations unless problems arose in the crediting and 
distribution of interest earnings. Thus, this bill would impose 
no new private-sector mandates as defined by UMRA. If after a 
period of time the FRB determined a rule was necessary, the FRB 
indicates that the form a rule would mostly likely take is to 
require that correspondent banks pass the interest earnings 
back to the institutions for which they maintain required 
balances at the Federal Reserve. The cost to the correspondent 
banks of complying with such a rule would be negligible.
    Estimate prepared by: Federal Revenues: Carolyn Lynch. 
Impact on the Government Sector: Susan Sieg Tompkins. Impact on 
the Private Sector: Patrice Gordon.
    Estimate approved by: G. Thomas Woodward, Assistant 
Director for Tax Analysis.

                      Section-by-Section Analysis


Section 1. Short title

    This Act may be cited as the ``Bank Reserves Modernization 
Act of 2000.''

Section 2. Payment of interest on reserves at Federal Reserve Banks

    This section permits the Federal Reserve to pay interest on 
the reserves that depository institutions maintain at Federal 
Reserve Banks at a rate not to exceed the general level of 
short-term interest rates. The Federal Reserve may prescribe 
regulations relating to payments and distributions. This 
section also permits funds to be transferred from the surplus 
funds of Federal Reserve Banks as a means to pay for the costs 
that are implicit to the bill.

         Changes in Existing Law Made by the Bill, as Reported

  In compliance with clause 3(e) of rule XIII of the Rules of 
the House of Representatives, changes in existing law made by 
the bill, as reported, are shown as follows (existing law 
proposed to be omitted is enclosed in black brackets, new 
matter is printed in italic, existing law in which no change is 
proposed is shown in roman):

                         FEDERAL RESERVE ACT

           *       *       *       *       *       *       *


  Sec. 7. (a) Dividends and Surplus Funds of Reserve Banks.--
          (1) * * *

           *       *       *       *       *       *       *

          (3) Payment to treasury.--During fiscal years 2001 
        through 2005, any amount in the surplus fund of any 
        Federal reserve bank in excess of the amount equal to 3 
        percent of the paid-in capital and surplus of the 
        member banks of such bank shall be transferred to the 
        Secretary of the Treasury for deposit in the general 
        fund of the Treasury.
  (b) Transfer For Fiscal Year 2000.--
          (1) * * *

           *       *       *       *       *       *       *

          (4) Additional transfers to cover interest payments 
        for fiscal years 2001 through 2005.--
                  (A) In general.--In addition to the amounts 
                required to be transferred from the surplus 
                funds of the Federal reserve banks pursuant to 
                paragraph (1), the Federal reserve banks shall 
                transfer from such surplus funds to the Board 
                of Governors of the Federal Reserve System for 
                transfer to the Secretary of the Treasury for 
                deposit in the general fund of the Treasury, 
                such sums as are necessary to equal the net 
                cost of section 19(b)(12), as estimated by the 
                Office of Management and Budget, in each of the 
                fiscal years 2001 through 2005.
                  (B) Allocation by federal reserve board.--Of 
                the total amount required to be paid by the 
                Federal reserve banks under subparagraph (A) 
                for fiscal years 2001 through 2005, the Board 
                of Governors of the Federal Reserve System 
                shall determine the amount each such bank shall 
                pay in such fiscal year.
                  (C) Replenishment of surplus fund 
                prohibited.--During fiscal years 2001 through 
                2005, no Federal reserve bank may replenish 
                such bank's surplus fund by the amount of any 
                transfer by such bank under subparagraph (A).

           *       *       *       *       *       *       *


                         division of earnings.

  Sec. 19. (a) * * *
  (b) Reserve Requirements.--
          (1) * * *

           *       *       *       *       *       *       *

          (4) Supplemental reserves.--(A) * * *

           *       *       *       *       *       *       *

          [(C) The supplemental reserve authorized under 
        subparagraph (A) shall be maintained by the Federal 
        Reserve banks in an Earnings Participation Account. 
        Except as provided in subsection (c)(1)(A)(ii), such 
        Earnings Participation Account shall receive earnings 
        to be paid by the Federal Reserve banks during each 
        calendar quarter at a rate not more than the rate 
        earned on the securities portfolio of the Federal 
        Reserve System during the previous calendar quarter. 
        The Board may prescribe rules and regulations 
        concerning the payment of earnings on Earnings 
        Participation Accounts by Federal Reserve banks under 
        this paragraph.]
          [(D)] (C) If a supplemental reserve under 
        subparagraph (A) has been required of depository 
        institutions for a period of one year or more, the 
        Board shall review and determine the need for continued 
        maintenance of supplemental reserves and shall transmit 
        annual reports to the Congress regarding the need, if 
        any, for continuing the supplemental reserve.
          [(E)] (D) Any supplemental reserve imposed under 
        subparagraph (A) shall terminate at the close of the 
        first 90-day period after such requirement is imposed 
        during which the average amount of reserves required 
        under paragraph (2) are less than the amount of 
        reserves which would be required during such period if 
        the initial ratios specified in paragraph (2) were in 
        effect.
          (12) Earnings on reserves.--
                  (A) In general.--Balances maintained at a 
                Federal reserve bank by or on behalf of a 
                depository institution may receive earnings to 
                be paid by the Federal reserve bank at least 
                once each calendar quarter at a rate or rates 
                not to exceed the general level of short-term 
                interest rates.
                  (B) Regulations relating to payments and 
                distribution.--The Board may prescribe 
                regulations concerning--
                          (i) the payment of earnings in 
                        accordance with this paragraph;
                          (ii) the distribution of such 
                        earnings to the depository institutions 
                        which maintain balances at such banks 
                        or on whose behalf such balances are 
                        maintained; and
                          (iii) the responsibilities of 
                        depository institutions, Federal home 
                        loan banks, and the National Credit 
                        Union Administration Central Liquidity 
                        Facility with respect to the crediting 
                        and distribution of earnings 
                        attributable to balances maintained, in 
                        accordance with subsection (c)(1)(B), 
                        in a Federal reserve bank by any such 
                        entity on behalf of depository 
                        institutions.
  (c)(1) Reserves held by a depository institution to meet the 
requirements imposed pursuant to subsection (b) shall, subject 
to such rules and regulations as the Board shall prescribe, be 
in the form of--
          (A) balances maintained for such purposes by such 
        depository institution in the Federal Reserve bank of 
        which it is a member or at which it maintains an 
        account, except that (i) the Board may, by regulation 
        or order, permit depository institutions to maintain 
        all or a portion of their required reserves in the form 
        of vault cash, except that any portion so permitted 
        shall be identical for all depository institutions, and 
        (ii) vault cash may be used to satisfy any supplemental 
        reserve requirement imposed pursuant to subsection 
        (b)(4), except that all such vault cash shall be 
        excluded from any computation of earnings pursuant to 
        [subsection (b)(4)(C)] subsection (b); and
          (B) balances maintained by a depository institution 
        [which is not a member bank] in a depository 
        institution which maintains required reserve balances 
        at a Federal Reserve bank, in a Federal Home Loan Bank, 
        or in the National Credit Union Administration Central 
        Liquidity Facility, if such depository institution, 
        Federal Home Loan Bank, or National Credit Union 
        Administration Central Liquidity Facility maintains 
        such funds in the form of balances in a Federal Reserve 
        bank of which it is a member or at which it maintains 
        an account. Balances received by a depository 
        institution from a second depository institution and 
        used to satisfy the reserve requirement imposed on such 
        second depository institution by this section shall not 
        be subject to the reserve requirements of this section 
        imposed on such first depository institution, and shall 
        not be subject to assessments or reserves imposed on 
        such first depository institution pursuant to section 7 
        of the Federal Deposit Insurance Act (12 U.S.C. 1817), 
        section 404 of the National Housing Act (12 U.S.C. 
        1727), or section 202 of the Federal Credit Union Act 
        (12 U.S.C. 1782).

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