Don’t Pay Banks Interest on Excess Reserves

The Federal Reserve pays banks interest on reserves and excess reserves. I believe eliminating the payment of interest on excess reserves will encourage banks to lend. In theory, banks will want to avoid the opportunity cost of holding excess reserves that pay them no interest.

Pursuant to the Emergency Economic Stabilization Act of 2008, the Federal Reserve started paying interest on bank reserves and excess reserves on October 1, 2008, a measure that accelerated the effective date of the Financial Services Regulatory Relief act of 2006 by 3 years. Labor statistics show that approximately 50% of American workers are employed by small businesses, and according to the United States Small Business Administration, 77% of new jobs are created by small businesses. Therefore, a greater focus should be placed encouraging small business creation, as well as helping existing small businesses expand and survive. I believe funds flowing from excess reserves towards lending will help in this capacity.

What I hear from bankers is that uncertainty and an environment in which it is difficult to comply with an abundance of regulation, imperils banks ability to increase their lending. And what I hear from small business owners and those who want to start a small business, is the banks are not lending – an impediment to the ability of many small businesses to get off the ground, expand, or sustain their existence.  Though there is no guarantee that banks will increase lending to small businesses if not being paid interest on excess reserves, the probability that banks will put the capital they hold in excess reserves to use would theoretically help spark economic activity, and potentially benefit the U.S. economy.


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