requirements to a minimum. to do so, they engage in a variety of reserve avoidance activities, including sweep arrangements that move funds from deposits that are subject to reserve requirements to those that are not and to money market investments. these sweep programs and similar activities absorb real resources and therefore diminish the efficiency of our banking institutions. the payment of interest on required reserve balances would remove a substantial portion of the incentive for depositories to engage in such reserve avoidance measures, and the resulting improvements in efficiency should eventually be passed through to bank borrowers and depositors. although paying interest on reserves would yield significant benefits, even greater efficiencies and regulatory burden reduction might be realized by substantially reducing, or even eliminating, reserve requirements. to understand how elimination of reserve requirements could be consistent with effective monetary policy and the other legislative changes that would be necessary to realize this greater reduction in regulatory burden, i need to review with you the role of reserve requirements in the implementation of monetary policy and alternatives that might be possible. the federal reserve ’ s federal open market committee ( fomc ) conducts monetary policy by setting a target for the overnight federal funds rate - the interest rate on loans between depository institutions of balances held at reserve banks. while the federal funds rate is a market interest rate, the federal reserve can strongly influence its level by adjusting the aggregate supply of balances held at reserve banks. it does so through open market operations - the purchase or sale of securities that causes increases or decreases in such balances. however, in deciding on the appropriate level of balances to supply in order to achieve the targeted funds rate, the federal reserve ’ s open market desk must estimate the aggregate demand for such balances. at present, a depository institution may hold three types of balances in its account at a federal reserve bank - required reserve balances, contractual clearing balances, and excess reserve balances. as noted above, required reserve balances are the balances that a depository institution must hold to meet reserve requirements. a depository institution holds contractual clearing balances when it needs a higher level of balances than its required reserve balances in order to pay checks or make wire transfers out of its account at the federal reserve without incurring overnight overdrafts. currently, such clearing balances do not earn explicit interest, but they do earn implicit interest for depository institutions in the form of credits that may be used to pay for federal reserve services, such as check clearing.

that meet community development needs without dictating whether the activity should be in the form of a loan, an investment, or a service. this flexibility was intended to help institutions in this size category that do not have the resources to engage in a wide range of investment activities, compete more fairly with larger financial institutions. the proposal also attempts to resolve a persistent problem for banks that operate in rural areas where census tracts tend to be middle - income but may contain distinct pockets of lower - income individuals. although financial institutions receive credit under the cra for activities that primarily serve low - and moderate - income individuals or geographies, the homogeneous nature of rural census tracts makes crediting such activities difficult. in fact, only 15 percent of rural census tracts are classified as low - or moderate - income tracts, and almost 60 percent of rural counties do not have a single low - or moderate - income tract. the proposal suggested several alternatives for defining what constitutes an underserved rural area and the agencies are still reviewing comments and working to determine which of these alternatives would best define the types of community development activity that should earn cra credit. anyone who has been involved in community development recognizes the importance of both hmda and the cra. these laws were designed to make the mortgage market more transparent, and they have largely succeeded. since their enactment, lenders have found lines of business that had not been previously tapped. new partnerships have been established between lenders and community organizations to meet the credit needs that have been identified through the use of hmda data. in general, the story has been positive for communities and lenders alike. still, challenges remain. at the same time that regulatory policy encouraged lenders to serve previously underserved individuals, technological advances in the loan - underwriting process allowed lenders to price for risk more efficiently, expanding access to mortgage credit. this expansion has occurred largely in the subprime market and has had both positive and negative effects. today, data show record high homeownership rates among low - income and minority borrowers, yet the reports of lending abuses and increased foreclosure rates loom as dark clouds on an otherwise bright horizon. even though subprime mortgage delinquencies generally are falling, default and foreclosures associated with such mortgages may have adversely affected some neighborhoods. thus, while it is encouraging that technology has increased the efficiency of the mortgage market, the small yet significant segment of the market in which problems persist cannot