April 17, 2025 • 10 mins
The payment by the Federal Reserve of interest on bank reserves may sound like an abstruse matter of economic theory, but these payments are critical to bank operations and the Fed’s conduct of monetary policy. In the latest episode — sponsored by Intrafi’s Banking with Interest — ABA’s Jeff Huther discusses why proposals to end or reduce interest on reserves are misguided. Among other things, Huther discusses:
- Why ending payments could have a destabilizing effect on the financial sector.
- Why, under today’s accounting practices, the federal government would see no near-term bottom-line boost from capturing those payments.
- How reducing or eliminating interest on reserves would disproportionately harm community banks.
Read more in Huther’s ABA DataBank post.
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Evan Sparks (00:02):
From the American Bankers Association, this is the
A BA Banking Journal podcast.
Welcome back.
I'm Evan Sparks.
Today's episode is presented by Intrafiand I'm delighted to be joined by
my a BA colleague Jeff Huther, inour office of the Chief Economist.
Jeff is an economist and previousFederal Reserve staffer who has
a lot of expertise on a varietyof eco monetary policy functions.
(00:23):
And one of the things I wanted to talkto him about is a recent a BA data
bank post that he wrote for us on thepayment of interest on bank reserves.
This is obviously a key component ofhow the Fed conducts monetary policy.
There are always proposals in the,in the ether to change what the Fed
might be doing in the reserve space.
(00:43):
But before we get to those Jeff, couldyou kind of just give a, give our
listeners for anyone who's not familiar,an overview of the Fed's current
approach to paying interest on reserves.
Jeff Huther (00:53):
Sure.
The rate gets set when the Fed reresets its interest rate policy targets,
and it's 10 basis points below thetop of the, the fed's range, which
is currently at 25 basis point range.
The payment reserves.
States back to 2008, and theFed had wanted to pay interest
(01:15):
on reserves for a long time.
It felt that as though it was constrainingits ability to implement monetary
policy through open market operations.
So once it got the authority,it, it went straight into
buying a lot of of securities.
Doing so raise the amountof reserves in the system.
(01:35):
That is, that when the Fedbuys re securities, it gives
banks reserves in, in exchange.
So that process of payingfor res for securities buying
mortgage backed securities andtreasury securities and paying.
Interest to banks has, has largelybeen profitable for the Fed
(01:57):
until the last couple of years.
When interest rates rose quickly,the securities that the Fed had
bought were very low interest ratethe average interest rate on their
mortgage backed security portfoliosaround two and a half percent.
And recall, they're paying4%, 4.4% on on reserves.
So right now they're in a.A money losing situation.
(02:21):
And that's been the, the realmotivator for, for proposals to,
to stop paying interest as a way tokind of get them out of the hole.
They've, they've dug for themselves.
Evan Sparks (02:48):
So if the Fed were to stop paying interest on reserves or to
reduce the amount it pays on reserves,in order to trim some of these some
of these the losses it may be taking,what would the impact on its monetary
policy decisions and practices be?
Jeff Huther (03:02):
Well, I, I think there are a couple of components.
One is that they would have topretty aggressively reduce the size
of their portfolio and that thatwould probably in involve SA sales
as well as letting securities rolloff is their current practice.
And the reason is that it just stoppingto pay interest right now would have a.
Huge negative effect on the banking sectorin a way that would be destabilizing.
(03:27):
Something like 65% of net incomelast year is, is roughly the
value of the interest on reservesthat, that the Fed paid to banks.
So you can imagine if, if you took awaythat, that that those interest payments.
That the, the, the bankingsystem would have to react in a
pretty, pretty substantial way.
(03:48):
Send their deposit rates to zerofind ways to avoid holding reserves.
And remember, it's a closed system,so there aren't too many ways to,
to get around paying interest.
Evan Sparks (04:03):
I want, I do want to take a quick moment here and thank our sponsor
for this episode, the A. This episodeof the A BA Banking Journal podcast
is sponsored by Banking with Interest,which is a podcast from Intrafi featuring
in-depth analysis and insight into thepolicy changes reshaping the banking
industry with insightful interviews andpreviews of pending policy challenges.
The podcast is an essentiallisten for anyone connected to
(04:24):
the financial services industry.
Banking with Interest is skillfullyhosted by Rob Blackwell, an award-winning
former journalist with more than twodecades of experience as an expert
on financial services policy, who'snow Chief Content Officer and Head
of External Affairs with Intrafi.
You can find more, findout more@Intrafi.com.
That's I-N-T-R-A-F i.com and find,find banking with interest on any
(04:45):
of your favorite podcast platforms.
It's like, and, and as I said in thesponsor read, it really is a great listen.
So moving back to the conversation with.
Jeff you know, we are looking ata you know, the, this question
of in of paying interest onreserves and the idea being that.
The Fed is now taking a lossbecause of the the mismatch in,
(05:08):
in, in the, the change in rates.
Would removing interest onreserves actually do anything
to help the federal budget?
And, you know, as we look at, you know,congress moving reconciliation bills, I
mean, is there, is there anything herethat would actually help, help deal
with you know, federal budget deficit?
Jeff Huther (05:26):
Not, not in the short run for sure.
The, the Feds has accu, the Fedhas accumulated a, a pretty large
deficit over the last few years,and that's they call a defer.
The, the accumulation of thosedeficits called a deferred asset,
that that deferred asset is nowworth some $200 billion that
(05:48):
the, that the Fed would have to.
Paybacks essentially pay itselfbefore it started returning
money to the US Treasury.
So the question would be howlong would would it take for them
to, to pay off that, that debt?
And the, the question iscomplicated by, well, what are,
what are interest rates gonna be?
How quickly is the are reservesgoing to go down if it were
(06:12):
to stop paying interest?
And so you could say for at least someyears there would be no, no, no revenue
generated from the Fed, even thoughit would have this a stream of income
that wouldn't have any subtractionagainst it in, in an ongoing sense
of a kind of a net interest margin.
(06:34):
It would be a very positive net interestmargin, but it would, would still.
Be used to pay this, this accumulateddebt that, that they've incurred.
Evan Sparks (06:44):
So we'd be looking at a number of years before we can act.
We'd actually see that to this whatin your, in your article, it's $216
billion you know, paid off withinthe, you know, accounting, you, the
accounting models that the Fed uses here.
Jeff Huther (07:00):
Yeah, yeah, yeah.
Evan Sparks (07:02):
And then so, so it's like, all right, so we're not getting.
An impact.
So if we were to stop paying, we're notgetting an impact on a on the budget,
we are seeing an impact on the Fed'sability to conduct monetary policy.
What is, what, what about theeffect of stop of CCing to pay
interest on reserves on bank?
On bank operations?
I mean, I assume banks are gonnasubstitute assets if they are if they're
(07:23):
not receiving, receiving payment onreserves that are held at the federal,
at their, at the Federal Reserve Banks.
Jeff Huther (07:30):
Yeah.
And that's a, that's a you know, from aneconomist point of view, that's kind of an
interesting question because the, there'sso few ways that banks can get rid of
reserves that, you know, if in a typicalframework, the reserves can be transferred
from one bank to another, but they canbe neither created or destroyed on the,
the, the bank side that's really up to theFed and how it manages its balance sheet.
(07:55):
Over last beginning in 2013 the Fedcreated an an out effectively for
reserves through some it's called,oh, it's called the overnight reverse
repo program or facility that.
That program absorbed a couple trilliondollars worth of of reserves in the
(08:16):
years during and after the, the pandemic.
That program might be a way for banks to
receiving interest.
And the way that would work would be thatthe, the banks that have access to to this
(08:38):
program would encourage their depositorsto take their money, put it into funds
that are then invested in the bankdirectly in the, in the overnight reverse
repo program through the bank or throughan affiliated money market mutual fund.
The problem with this ability to shiftmoney into a interest bearing account
(09:02):
is that it's really set up for the largebanks and the smaller banks don't meet
the fed's standards for counterparties.
They have to have 30 billion in assetsbefore they even want to talk to you.
So it's not an easy program for orit's not a program that would be easy
(09:23):
for your, for your typical bank toaccess and find a way to get interest
instead of getting interest on reserves.
So.
The big budgetary effect would probablybe negated by the big banks moving
their, their reserves into this program.
The small banks would suffer interms of not being able to get
(09:46):
interest on the reserves and notbeing able to access the program.
Evan Sparks (09:50):
This proposal out there, I have no idea what the people who are
advocating for it want, but it soundslike it's something that's just kinda
net negative, certainly for the smaller,for smaller community banks, if you are
switching the you know, limiting theability to access interest on reserves.
Yeah.
Yeah.
All right.
Well, that was a very, that's a very,it's a very interesting topic as always.
(10:12):
I, I learned something new fromyou, Jeff, and I appreciate and
from, from your colleagues at inthe Office of the Chief Economist.
For those of you who are listening, youcan find Jeff's piece at aba.com/databank
or on the ABA Banking Journal website.
Go ahead and take a look at that.
Very informative.
And then we, there's a whole bunch ofother information on Abba's website from
(10:33):
our Office of the Chief Economist with andfrom our EE our economic research team.
So, go again.
Go ahead and check that out@aba.com.
Thanks again to Intrafi and theBanking with Interest podcast
for sponsoring this episode.
And thanks so much to you for listening.
We'll be back with you again very soon.
From the American Bankers Association, this is the
A BA Banking Journal podcast.
Welcome back.
I'm Evan Sparks.
Today's episode is presented by Intrafiand I'm delighted to be joined by
my a BA colleague Jeff Huther, inour office of the Chief Economist.
Jeff is an economist and previousFederal Reserve staffer who has
a lot of expertise on a varietyof eco monetary policy functions.
(00:23):
And one of the things I wanted to talkto him about is a recent a BA data
bank post that he wrote for us on thepayment of interest on bank reserves.
This is obviously a key component ofhow the Fed conducts monetary policy.
There are always proposals in the,in the ether to change what the Fed
might be doing in the reserve space.
(00:43):
But before we get to those Jeff, couldyou kind of just give a, give our
listeners for anyone who's not familiar,an overview of the Fed's current
approach to paying interest on reserves.
Jeff Huther (00:53):
Sure.
The rate gets set when the Fed reresets its interest rate policy targets,
and it's 10 basis points below thetop of the, the fed's range, which
is currently at 25 basis point range.
The payment reserves.
States back to 2008, and theFed had wanted to pay interest
(01:15):
on reserves for a long time.
It felt that as though it was constrainingits ability to implement monetary
policy through open market operations.
So once it got the authority,it, it went straight into
buying a lot of of securities.
Doing so raise the amountof reserves in the system.
(01:35):
That is, that when the Fedbuys re securities, it gives
banks reserves in, in exchange.
So that process of payingfor res for securities buying
mortgage backed securities andtreasury securities and paying.
Interest to banks has, has largelybeen profitable for the Fed
(01:57):
until the last couple of years.
When interest rates rose quickly,the securities that the Fed had
bought were very low interest ratethe average interest rate on their
mortgage backed security portfoliosaround two and a half percent.
And recall, they're paying4%, 4.4% on on reserves.
So right now they're in a.A money losing situation.
(02:21):
And that's been the, the realmotivator for, for proposals to,
to stop paying interest as a way tokind of get them out of the hole.
They've, they've dug for themselves.
Evan Sparks (02:48):
So if the Fed were to stop paying interest on reserves or to
reduce the amount it pays on reserves,in order to trim some of these some
of these the losses it may be taking,what would the impact on its monetary
policy decisions and practices be?
Jeff Huther (03:02):
Well, I, I think there are a couple of components.
One is that they would have topretty aggressively reduce the size
of their portfolio and that thatwould probably in involve SA sales
as well as letting securities rolloff is their current practice.
And the reason is that it just stoppingto pay interest right now would have a.
Huge negative effect on the banking sectorin a way that would be destabilizing.
(03:27):
Something like 65% of net incomelast year is, is roughly the
value of the interest on reservesthat, that the Fed paid to banks.
So you can imagine if, if you took awaythat, that that those interest payments.
That the, the, the bankingsystem would have to react in a
pretty, pretty substantial way.
(03:48):
Send their deposit rates to zerofind ways to avoid holding reserves.
And remember, it's a closed system,so there aren't too many ways to,
to get around paying interest.
Evan Sparks (04:03):
I want, I do want to take a quick moment here and thank our sponsor
for this episode, the A. This episodeof the A BA Banking Journal podcast
is sponsored by Banking with Interest,which is a podcast from Intrafi featuring
in-depth analysis and insight into thepolicy changes reshaping the banking
industry with insightful interviews andpreviews of pending policy challenges.
The podcast is an essentiallisten for anyone connected to
(04:24):
the financial services industry.
Banking with Interest is skillfullyhosted by Rob Blackwell, an award-winning
former journalist with more than twodecades of experience as an expert
on financial services policy, who'snow Chief Content Officer and Head
of External Affairs with Intrafi.
You can find more, findout more@Intrafi.com.
That's I-N-T-R-A-F i.com and find,find banking with interest on any
(04:45):
of your favorite podcast platforms.
It's like, and, and as I said in thesponsor read, it really is a great listen.
So moving back to the conversation with.
Jeff you know, we are looking ata you know, the, this question
of in of paying interest onreserves and the idea being that.
The Fed is now taking a lossbecause of the the mismatch in,
(05:08):
in, in the, the change in rates.
Would removing interest onreserves actually do anything
to help the federal budget?
And, you know, as we look at, you know,congress moving reconciliation bills, I
mean, is there, is there anything herethat would actually help, help deal
with you know, federal budget deficit?
Jeff Huther (05:26):
Not, not in the short run for sure.
The, the Feds has accu, the Fedhas accumulated a, a pretty large
deficit over the last few years,and that's they call a defer.
The, the accumulation of thosedeficits called a deferred asset,
that that deferred asset is nowworth some $200 billion that
(05:48):
the, that the Fed would have to.
Paybacks essentially pay itselfbefore it started returning
money to the US Treasury.
So the question would be howlong would would it take for them
to, to pay off that, that debt?
And the, the question iscomplicated by, well, what are,
what are interest rates gonna be?
How quickly is the are reservesgoing to go down if it were
(06:12):
to stop paying interest?
And so you could say for at least someyears there would be no, no, no revenue
generated from the Fed, even thoughit would have this a stream of income
that wouldn't have any subtractionagainst it in, in an ongoing sense
of a kind of a net interest margin.
(06:34):
It would be a very positive net interestmargin, but it would, would still.
Be used to pay this, this accumulateddebt that, that they've incurred.
Evan Sparks (06:44):
So we'd be looking at a number of years before we can act.
We'd actually see that to this whatin your, in your article, it's $216
billion you know, paid off withinthe, you know, accounting, you, the
accounting models that the Fed uses here.
Jeff Huther (07:00):
Yeah, yeah, yeah.
Evan Sparks (07:02):
And then so, so it's like, all right, so we're not getting.
An impact.
So if we were to stop paying, we're notgetting an impact on a on the budget,
we are seeing an impact on the Fed'sability to conduct monetary policy.
What is, what, what about theeffect of stop of CCing to pay
interest on reserves on bank?
On bank operations?
I mean, I assume banks are gonnasubstitute assets if they are if they're
(07:23):
not receiving, receiving payment onreserves that are held at the federal,
at their, at the Federal Reserve Banks.
Jeff Huther (07:30):
Yeah.
And that's a, that's a you know, from aneconomist point of view, that's kind of an
interesting question because the, there'sso few ways that banks can get rid of
reserves that, you know, if in a typicalframework, the reserves can be transferred
from one bank to another, but they canbe neither created or destroyed on the,
the, the bank side that's really up to theFed and how it manages its balance sheet.
(07:55):
Over last beginning in 2013 the Fedcreated an an out effectively for
reserves through some it's called,oh, it's called the overnight reverse
repo program or facility that.
That program absorbed a couple trilliondollars worth of of reserves in the
(08:16):
years during and after the, the pandemic.
That program might be a way for banks to
receiving interest.
And the way that would work would be thatthe, the banks that have access to to this
(08:38):
program would encourage their depositorsto take their money, put it into funds
that are then invested in the bankdirectly in the, in the overnight reverse
repo program through the bank or throughan affiliated money market mutual fund.
The problem with this ability to shiftmoney into a interest bearing account
(09:02):
is that it's really set up for the largebanks and the smaller banks don't meet
the fed's standards for counterparties.
They have to have 30 billion in assetsbefore they even want to talk to you.
So it's not an easy program for orit's not a program that would be easy
(09:23):
for your, for your typical bank toaccess and find a way to get interest
instead of getting interest on reserves.
So.
The big budgetary effect would probablybe negated by the big banks moving
their, their reserves into this program.
The small banks would suffer interms of not being able to get
(09:46):
interest on the reserves and notbeing able to access the program.
Evan Sparks (09:50):
This proposal out there, I have no idea what the people who are
advocating for it want, but it soundslike it's something that's just kinda
net negative, certainly for the smaller,for smaller community banks, if you are
switching the you know, limiting theability to access interest on reserves.
Yeah.
Yeah.
All right.
Well, that was a very, that's a very,it's a very interesting topic as always.
(10:12):
I, I learned something new fromyou, Jeff, and I appreciate and
from, from your colleagues at inthe Office of the Chief Economist.
For those of you who are listening, youcan find Jeff's piece at aba.com/databank
or on the ABA Banking Journal website.
Go ahead and take a look at that.
Very informative.
And then we, there's a whole bunch ofother information on Abba's website from
(10:33):
our Office of the Chief Economist with andfrom our EE our economic research team.
So, go again.
Go ahead and check that out@aba.com.
Thanks again to Intrafi and theBanking with Interest podcast
for sponsoring this episode.
And thanks so much to you for listening.
We'll be back with you again very soon.
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