[Federal Register Volume 84, Number 48 (Tuesday, March 12, 2019)]
[Proposed Rules]
[Pages 8829-8831]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-04348]


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 Proposed Rules
                                                 Federal Register
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 This section of the FEDERAL REGISTER contains notices to the public of 
 the proposed issuance of rules and regulations. The purpose of these 
 notices is to give interested persons an opportunity to participate in 
 the rule making prior to the adoption of the final rules.
 
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 

  Federal Register / Vol. 84, No. 48 / Tuesday, March 12, 2019 / 
Proposed Rules  

[[Page 8829]]



FEDERAL RESERVE SYSTEM

12 CFR Part 204

[Docket No. R-1652; RIN 7100-AF-40]


Regulation D: Reserve Requirements of Depository Institutions

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Advance notice of proposed rulemaking.

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SUMMARY: The Board of Governors of the Federal Reserve System (Board) 
is requesting comment on whether it should propose amendments to its 
Regulation D (Reserve Requirements of Depository Institutions, to lower 
the rate of interest paid on excess balances (``IOER'') maintained at 
Federal Reserve Banks (Reserve Banks) by eligible institutions that 
hold a very large proportion of their assets in the form of balances at 
Reserve Banks.

DATES: Comments must be received no later than May 13, 2019.

ADDRESSES: You may submit comments, identified by Docket Number R-1652; 
RIN 7100-AF-40, by any of the following methods:
     Agency website: http://www.federalreserve.gov. Follow the 
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
     Email: [email protected]. Include the 
docket number and RIN in the subject line of the message.
     Fax: (202) 452-3819 or (202) 452-3102.
     Mail: Ann E. Misback, Secretary, Board of Governors of the 
Federal Reserve System, 20th Street and Constitution Avenue NW, 
Washington, DC 20551.
    All public comments are available from the Board's website at 
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as 
submitted, unless modified for technical reasons or to remove 
personally identifiable information at the commenter's request. 
Accordingly, comments will not be edited to remove any identifying or 
contact information. Public comments may also be viewed electronically 
or in paper in Room 146, 1709 New York Avenue NW, Washington, DC 20006, 
between 9:00 a.m. and 5:00 p.m. on weekdays.

FOR FURTHER INFORMATION CONTACT: Sophia H. Allison, Senior Special 
Counsel, (202-452-3565), or Gavin Smith, Senior Counsel, (202-452-
3474), Legal Division, or Marnie Gillis DeBoer, Associate Director 
(202-452-3139), or Mary-Frances Styczynski, Senior Financial Analyst 
(202-452-3303), Division of Monetary Affairs; for users of 
Telecommunications Device for the Deaf (TDD) only, contact 202-263-
4869; Board of Governors of the Federal Reserve System, 20th and C 
Streets NW, Washington, DC 20551.

SUPPLEMENTARY INFORMATION:

I. Statutory and Regulatory Background

    Section 19 of the Federal Reserve Act (``Act'') provides that 
Reserve Banks may pay interest on balances maintained by or on behalf 
of certain institutions in an account at a Reserve Bank at a rate or 
rates not to exceed the general level of short-term interest rates 
(``IOR'' authority). Institutions that are eligible to receive interest 
on their balances held at Reserve Banks (``eligible institutions'') 
include ``depository institutions'' and certain other institutions.\1\ 
This authority to pay interest does not extend to all balances 
maintained at Reserve Banks, such as balances of the Federal Home Loan 
Banks and of certain other non-depository institutions.\2\ There is no 
requirement in the statute that interest be paid to any eligible 
institution, nor is there any requirement that the same interest rate 
or rates be paid to all eligible institutions or on all balances of 
eligible institutions.
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    \1\ See 12 U.S.C. 461(b)(1)(A) & (b)(12)(C); see also 12 CFR 
204.2(y) (definition of ``eligible institution'').
    \2\ 12 U.S.C. 1435 (Federal Home Loan Banks); see, e.g., 12 
U.S.C. 1452(d) (Freddie Mac), 22 U.S.C. 285d (Asian Development 
Bank).
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    Section 19 of the Act also provides that the Board may prescribe 
regulations concerning the payment of interest on balances at a Reserve 
Bank.\3\ The Board first authorized IOR in an October 2008 interim 
final rule amending its Regulation D.\4\ Specifically, section 204.10 
of Regulation D specifies the types of balances on which interest may 
be paid, the interest rates applicable to those balances, and the 
method for calculating interest. Reserve Banks may pay interest on 
balances that are maintained to satisfy an institution's reserve 
balance requirement (sometimes called ``required reserve balances''), 
and also may pay interest on balances that are in excess of required 
reserves (excess reserves). Section 204.10 specifies an ``IORR'' 
(interest on required reserve balances) rate and an IOER (interest on 
excess reserves) rate. Regulation D currently provides that the IORR 
rate is 2.40 percent and that the IOER rate is 2.40 percent.\5\
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    \3\ See 12 U.S.C. 461(b)(12).
    \4\ Regulation D Interim Final Rule, 73 FR 59482 (Oct. 9, 2008).
    \5\ See 12 CFR 204.10(b)(5) (setting forth IORR and IOER rates).
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II. Discussion

A. Recent Developments in Chartering Activity

    Some financial firms recently have sought to establish special 
state charters for depository institutions with narrowly focused 
business models that involve taking deposits from institutional 
investors and investing all or substantially all of the proceeds in 
balances at Reserve Banks. These narrowly focused depository 
institutions would not be subject to federal prudential regulation and 
would not be subject to the same set of capital and other prudential 
requirements as other federally regulated banks.
    As explained in greater detail below, these narrowly focused 
depository institutions (Pass-Through Investment Entities or PTIEs) 
could theoretically attract a very large quantity of deposits from 
institutional investors by paying a rate that is nearly identical to 
the IOER rate. In effect, these PTIEs would pass through the interest 
obtained at the IOER rate from a Reserve Bank to their depositors, less 
a small spread.
    The Board has not yet determined whether any or all PTIEs would 
meet the definition of ``eligible institution'' in Regulation D.\6\ 
Assuming a PTIE were determined to be an ``eligible institution,'' and 
assuming that a Reserve Bank were to exercise its discretion to grant 
that PTIE a master

[[Page 8830]]

account, the PTIE could earn interest on balances that it maintains at 
a Reserve Bank.\7\ Under the current provisions of Regulation D, this 
would enable PTIEs to earn interest on their balances at a Reserve Bank 
at the IORR and IOER rate, yet at the same time avoid the costs borne 
by other eligible institutions, such as the costs of capital 
requirements and the other elements of federal regulation and 
supervision, because of the limited scope of their product offerings 
and asset types.
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    \6\ 12 CFR 204.2(y) (definition of ``eligible institution'').
    \7\ Section 13 of the Federal Reserve Act, 12 U.S.C. 342. All 
subsequent references to ``eligible institutions'' in this advance 
notice of proposed rulemaking assume that such institutions have 
been granted master accounts at the discretion of a Reserve Bank.
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    Avoiding regulatory costs borne by other eligible institutions and 
unconstrained by meaningful capital requirements, PTIEs could 
effectively extend the IOER rate to their depositors that are not 
themselves ``eligible institutions,'' and would be able to do so on a 
potentially very large scale. A proliferation of similar PTIEs could 
magnify these effects across the financial system.
    The Board is concerned that PTIEs, by maintaining all or 
substantially all of their assets in the form of balances at Reserve 
Banks and having the ability to attract very large quantities of 
deposits at a near-IOER rate, have the potential to complicate the 
implementation of monetary policy.\8\ In addition, the Board is 
concerned that PTIEs could disrupt financial intermediation in ways 
that are hard to anticipate, and could also have a negative effect on 
financial stability, as described in greater detail below.
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    \8\ Depository institution balances at Reserve Banks as a share 
of assets varies widely across individual depository institutions, 
reflecting differences in their business needs for liquidity and 
differences in overall asset-liability management strategies. 
However, in aggregate, reserve balances currently amount to roughly 
10 percent of the assets of depository institutions and very few 
depository institutions maintain reserve balances that exceed 50 
percent of their assets.
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B. Monetary Policy Implementation

    Although the Board is concerned that PTIEs could complicate the 
implementation of monetary policy, some market participants have argued 
that the presence of PTIEs could help the implementation of monetary 
policy. Under this view, the presence of PTIEs, by essentially 
expanding the counterparties to which IOER is paid, could strengthen 
IOER as a tool for managing the level of short-term interest rates. 
Specifically, under this view, the activities of PTIEs could narrow the 
spread between short-term rates and the IOER rate, potentially 
strengthening the ability of the Federal Reserve to manage the level of 
short-term interest rates.
    The Board believes that monetary policy implementation has been 
very successful in maintaining the federal funds rate within the target 
range established by the Federal Open Market Committee (FOMC). The 
movements of other short-term money market interest rates have also 
tracked closely the changes in the target range for the federal funds 
rate. Accordingly, the potential benefits of PTIEs in enhancing 
monetary policy implementation appear to be quite modest. Moreover, the 
Board believes that PTIEs could present significant challenges for 
monetary policy implementation along a number of lines, as described 
below.
    The viability of the PTIE business model relies on the IOER rate 
being slightly above the level of certain other key overnight money 
market rates. Under these circumstances, as outlined above, PTIEs could 
potentially attract a large quantity of deposits and maintain very 
large balances at Reserve Banks. The ability of PTIEs to attract a very 
large amount of deposits at a rate above other key overnight money 
market rates could affect the FOMC's plans to reduce its balance sheet 
to the smallest level consistent with efficient and effective 
implementation of monetary policy. Specifically, if deposits at PTIEs 
were to become an especially attractive asset for cash investors, the 
demand for reserve balances by PTIEs could become quite large. In order 
to maintain the desired stance of monetary policy, the Federal Reserve 
would likely need to accommodate this demand by expanding its balance 
sheet and the supply of reserves.
    Depending on the constellation of interest rates, PTIEs could be an 
attractive investment for lenders in short-term funding markets such as 
the federal funds market. If the current lenders in the federal funds 
market shifted much of their overnight investment to deposits at PTIEs, 
the federal funds rate could become volatile. Such a development could 
require the FOMC to change its policy target on relatively short 
notice. Moreover, a marked change in the volatility of the federal 
funds rate could have spillover effects in many other markets that are 
linked to the federal funds rate such as federal funds futures, 
overnight index swaps, and floating-rate bank loans.
    More generally, a large-scale migration of institutional cash 
investors to deposits at PTIEs and away from other depository 
institutions, money market mutual funds, or repo markets could result 
in smaller trading volumes across a range of unsecured and secured 
overnight money markets. If this shift were large enough, or if cash 
shifted into or out of PTIEs rapidly, the reference rates derived from 
reported transactions in those markets, such as the overnight bank 
funding rate (OBFR), could also become volatile. This volatility could 
make it difficult for the Federal Reserve to control short-term rates 
more broadly as a means of implementing monetary policy.

C. Financial Intermediation

    The Board is also concerned that the presence of PTIEs could have 
unpredictable effects on financial intermediation broadly, potentially 
reshaping the financial industry in various ways that could raise the 
costs of private financial intermediation.
    Deposits at PTIEs, as noted above, could become attractive 
investments for many lenders in overnight funding markets. Lenders in 
the overnight general collateral (``GC'') repo market could find PTIE 
deposits more attractive than continued activity in the overnight GC 
repo market. If the rise of PTIEs were to reduce demand for GC repo 
lending, securities dealers could find it more costly to finance their 
inventories of Treasury securities. Such a development could impair the 
liquidity of the repo market, making it harder for banks to monetize 
Treasury securities in times of stress and raising the overall cost of 
Treasury borrowing. A decline in the robustness of the repo market 
could also have implications for the success of the decision of the 
Alternative Reference Rates Committee to base LIBOR's replacement on 
the U.S. Treasury repo market.\9\
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    \9\ https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2018/ARRC-Sept-20-2018-FAQ.
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    PTIEs could also diminish the availability of funding for 
commercial banks generally. To the extent that deposits at PTIEs are 
seen as a more attractive investment for cash investors that currently 
hold bank deposits, these investors could shift some of their 
investments from deposits issued by banks to deposits with PTIEs. This 
shift in investment, in turn, could raise bank funding costs and 
ultimately raise the cost of credit provided by banks to households and 
businesses.
    Some have argued that the presence of PTIEs could play an important 
role in raising deposit rates offered by banks to their retail 
depositors. The potential for rates offered by PTIEs to have a 
meaningful impact on retail deposit rates, however, seems very low. To 
the extent that the deposits of PTIEs would

[[Page 8831]]

be marketed largely to institutional investors, it seems very unlikely 
that the expansion of PTIEs would result in meaningfully higher rates 
on retail deposit accounts. Such retail deposit accounts have long paid 
rates of interest far below those offered on money market investments, 
reflecting factors such as bank costs in managing such retail accounts 
and the willingness of retail customers to forgo some interest on 
deposits for the perceived convenience or safety of maintaining 
balances at a bank rather than in a money market investment. 
Accordingly, the Board believes that PTIEs would play a limited, or no, 
role in raising overall retail deposit interest rates.

D. Financial Stability

    The Board also is concerned about the uncertainty that PTIEs may 
present for financial stability. Some have argued that deposits at 
PTIEs could improve financial stability because deposits at PTIEs, 
which would be viewed as virtually free of credit and liquidity risk, 
would help satisfy investors' demand for safe money-like instruments. 
According to this line of argument, the growth of PTIEs could reduce 
the creation of private money-like assets that have proven to be highly 
vulnerable to runs and to pose serious risks to financial stability. 
Some might also argue that PTIE deposits could reduce the systemic 
footprint of large banks by reducing the relative attractiveness to 
cash investors of deposits placed at these large banks.
    The Board believes, however, that the emergence of PTIEs likely 
would have negative financial stability effects on net. Deposits at 
PTIEs could significantly reduce financial stability by providing a 
nearly unlimited supply of very attractive safe-haven assets during 
periods of financial market stress. PTIE deposits could be seen as more 
attractive than Treasury bills, because they would provide 
instantaneous liquidity, could be available in very large quantities, 
and would earn interest at an administered rate that would not 
necessarily fall as demand surges. As a result, in times of stress, 
investors that would otherwise provide short-term funding to 
nonfinancial firms, financial institutions, and state and local 
governments could rapidly withdraw that funding from those borrowers 
and instead deposit those funds at PTIEs. The sudden withdrawal of 
funding from these borrowers could greatly amplify systemic stress.

E. Congressional Intent Considerations

    When Congress amended the Act to authorize Reserve Banks to pay 
interest on balances of depository institutions, it specifically 
restricted the receipt of such interest to a limited class of 
institutions. The Board is concerned that paying IOER to PTIEs would 
effectively amount to paying IOER to entities (for example, 
institutional investors that in many instances are not authorized to 
maintain balances at Reserve Banks) that Congress did not intend to 
receive it.\10\ As such, the payment of IOER in such cases could be 
viewed as inconsistent with the intent of Congress in providing the 
Federal Reserve with the authority to pay interest on balances 
maintained by the institutions specified in the Act.
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    \10\ The extension of IOER to non-eligible entities could be 
spread to numerous non-eligible entities through a PTIE, or it could 
be extended to one non-eligible entity if, for example, a PTIE were 
established by a single large domestic or foreign financial or 
commercial firm for its own cash management purposes.
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III. Request for Comment

A. General Proposals

    As discussed above, the Board recognizes that there are both 
potential benefits and potential costs associated with the presence of 
PTIEs in the U.S. financial system. The Board believes that the 
potential negative impact of PTIEs on monetary policy implementation, 
financial intermediation, and financial stability would outweigh the 
potential benefits if the Reserve Banks paid IOER to PTIEs.
    In response to these concerns, the Board is requesting comment on 
whether it should amend Regulation D to provide for a lower IOER rate 
for PTIEs.\11\ PTIEs could be identified as any eligible institution 
that holds a very large share of its assets in the form of balances at 
a Reserve Bank. Alternatively, PTIEs could be identified as any 
eligible institution that holds a very low level of capital relative to 
its assets. A PTIE also could be defined more narrowly as an eligible 
institution that (i) has a very high reserves/assets ratio or very low 
capital/assets ratio; and (ii) is not subject to supervision by a 
federal banking agency (e.g., the Board, the Office of the Comptroller 
of the Currency, the Federal Deposit Insurance Corporation, or the 
National Credit Union Administration). In all of these alternatives, 
the Board expects that it would define PTIE such that the vast majority 
of existing eligible institutions would continue to be paid the current 
IOER rate on all of their excess balances.
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    \11\ Central banks in other countries, for example New Zealand 
and Norway, have found it necessary to limit the amount of central 
bank balances that individual institutions may maintain for various 
reasons related to the implementation of monetary policy.
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    In terms of a lower IOER rate, Reserve Banks could pay a rate of 
zero on all the excess balances of such institutions. Alternatively, 
Reserve Banks could pay such institutions IOER up to a certain level of 
balances held at a Reserve Bank (as a percentage of the institution's 
total assets or total capital) and a lower or zero rate on balances 
above this level.
    The Board seeks comment on all aspects of this advance notice of 
proposed rulemaking, including the potential public policy costs and 
benefits of PTIEs discussed in the previous section, the general 
regulatory proposals to change the IOER framework in this section, and 
the more specific questions presented below.

B. Specific Questions

    In addition to the foregoing, the Board is also seeking comment on 
the following questions:
    1. Has the Board identified all of the relevant public policy 
concerns associated with PTIEs? Are there additional public policy 
concerns that the Board should consider?
    2. Are there public policy benefits of PTIEs that could outweigh 
identified concerns?
    3. If the Board were to determine to pay a lower IOER rate to 
PTIEs, how should the Board define those eligible institutions to which 
a lower IOER rate should be paid?
    4. If the Board were to determine to pay a lower IOER rate to 
PTIEs, what approach should the Board adopt for setting the lower rate?
    5. Are there any other limitations that could be applied to PTIEs 
that might increase the likelihood that such institutions could benefit 
the public while mitigating the public policy concerns outlined above?

    By order of the Board of Governors of the Federal Reserve 
System, March 6, 2019.
Margaret McCloskey Shanks,
Deputy Secretary of the Board.
[FR Doc. 2019-04348 Filed 3-11-19; 8:45 am]
 BILLING CODE 6210-01-P