89–006

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.’’.

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(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.

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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 ReVerDate 11-MAY-2000 18:37 Oct 18, 2000 Jkt 089006 PO 00000 Frm 00003 Fmt 6659 Sfmt 6602 E:\HR\OC\HR983.XXX pfrm11 PsN: HR983
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serve 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

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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.

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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 FedVerDate 11-MAY-2000 18:37 Oct 18, 2000 Jkt 089006 PO 00000 Frm 00006 Fmt 6659 Sfmt 6602 E:\HR\OC\HR983.XXX pfrm11 PsN: HR983
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eral 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.

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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

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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

10

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 paidin 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.

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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 payas-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.

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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

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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

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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)***

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ø(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.¿

ø(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.

ø(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;

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(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 øsubsection (b)(4)(C)¿ subsection (b); and

(B) balances maintained by a depository institution øwhich

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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