Moving quickly to implement one provision of the Emergency Economic Stabilization Act (EESA), the Federal Reserve Board announced on October 6 that it would begin paying interest on reserves.

The Financial Services Regulatory Relief Act of 2006 originally authorized the Federal Reserve to begin paying interest on reserve balances held by or on behalf of depository institutions beginning October 1, 2011. The EESA accelerated the effective date to October 1, 2008.

Employing the accelerated authority, the Board quickly amended its Regulation D (Reserve Requirements of Depository Institutions) to direct the Federal Reserve Banks to pay interest on required reserve balances (that is, balances held to satisfy depository institutions’ reserve requirements) and on excess balances (balances held in excess of required reserve balances and clearing balances).

As it announced the change, the Fed noted that paying interest on excess reserve balances will give it greater scope to use its lending programs to address conditions in credit markets while also maintaining the federal funds rate close to the target established by the Federal Open Market Committee.

The rate paid on required reserve balances will be the average targeted federal funds rate established by the Federal Open Market Committee over each reserve maintenance period less 10 basis points. The rate paid on excess balances will be set initially as the lowest targeted federal funds rate for each reserve maintenance period less 75 basis points.

The revisions to Regulation D took effect on Thursday, October 9, 2008. The Fed expects that many depository institutions will adjust their liquidity management practices in light of the payment of interest on reserves. The Fed emphasized that its primary credit program and other Federal Reserve liquidity facilities are available to help institutions meet temporary funding requirements. Also, while the change is already in effect, banks can take the opportunity to comment on the changes until November 21.