The Fed to Pay Interest on Depository Institutions

With conditions in U.S. and global financial markets remaining persistently strained, the Federal Reserve announced Monday that it will begin to pay interest on depository institutions’ required and excess reserve balances.

According to Fed the payment of interest on excess reserves will permit the Federal Reserve to expand its balance sheet, give it greater scope to use its lending programs while maintaining the federal funds rate close to the target established by the FOMC, and provide the liquidity needed to support the credit markets. The interest rate paid on required reserve balances, said the Fed, will be the average targeted federal funds rate established by the FOMC over each reserve maintenance period less 10 basis points.

The Fed also announced that it is substantially increasing the sizes of both 28-day and 84-day Term Auction Facility (TAF) auctions, beginning with today’s auction of 84-day funds. Both auctions will be boosted to $150 billion each. These increases will eventually bring the amounts outstanding under the regular TAF program to $600 billion.

In addition, notes the Fed in its statement – the sizes of the two forward TAF auctions to be conducted in November to extend credit over year end have been increased to $150 billion each.

These auctions will allow depository institutions to borrow from the Federal Reserve for a fixed term against the same collateral that is accepted at the discount window.

The Fed points out that the primary credit program and other Federal Reserve liquidity facilities are available to help institutions meet temporary funding requirements.

Meanwhile, the Treasury Department announced that it will make adjustments to its auction calendar. In an early morning statement Treasury said that it is “considering its options regarding the frequency and issuance of additional nominal coupons, including a reintroduction of the 3-year note, beginning in November 2008”.

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