Implementing Reserve Requirements Primarily Involves Depository Institutions and the Federal Reserve and Can Affect Customers

Implementing and enforcing transaction account reserve requirements  (and therefore the distinction between reservable transaction accounts  and nonreservable savings deposits through the “savings deposit”  definition in Regulation D) imposes administrative responsibilities for  depository institutions, the Board of Governors, and Reserve Banks and  can affect the customers of depository institutions. Banks and credit unions differed in how they monitored accounts to enforce the transaction limit. Because they shifted  funds from transaction accounts to savings deposits to reduce balances  in transaction accounts subject to reserve requirements, these institutions  had to enforce the transfer and withdrawal limit for savings deposits  (ensuring that the automatic transfers from savings deposits did not  exceed six times per month). The reasons depository institutions cited for maintaining  reserves on savings deposits (i.e., classifying both transaction accounts  and savings deposits as transaction accounts) to eliminate the need to  enforce the transaction limit included: (1) net transaction account  balances were low enough that holding additional reserves did not  increase the institution’s required reserve ratio, (2) customer feedback  (questions or concerns about the transaction limit), and (3) the Federal  Reserve’s payment of interest on reserves. Few (1 percent) depository institutions indicated that more than 10 percent of their customers’ savings deposits exceeded the transaction limit in a month or during a statement cycle. In one instance, representatives from a depository institution we  interviewed also told us that a change in policy (from classifying savings  deposits as transaction accounts and maintaining reserves against them  to avoid enforcing the transaction limit to classifying those accounts as  savings deposits and enforcing the transaction limit) caused confusion  among their customers and prompted complaints. Options to Reduce or Eliminate Reserve Requirements Have Monetary Policy Implications

Internationally,  many central banks have taken steps to reduce their  reliance on reserve requirements, including eliminating them completely  in some cases. While the ability to extend these experiences to the United States context  is unclear, they provide examples of monetary policy implementation  frameworks that do not involve mandatory reserve requirements. A Number of Central Banks Have Reduced Their Reliance on Reserve Requirements

Due, in part, to concerns about the cost, burdens and market distortions  associated with their use, there has been a decline in the level and use of  reserve requirements globally. Other developed  and emerging countries have operated with a reserve requirement  imposed on all deposits, which eliminates the need for measures like  transaction limits on certain kinds of transfers and withdrawals from  certain deposit liabilities to distinguish between reservable and  nonreservable deposits. This approach allowed the Federal Reserve to expand  its balance sheet to promote financial stability while maintaining control  over the federal funds rate. Because of the unique features of the U.S. financial system, it is  unclear that the practices used by other countries would translate to  the United States. A key objective in an interest rate targeting  procedure—which includes corridor operating approaches—is to limit the  volatility of the interest rate around the targeted level because of the cost  associated with the signals it sends to market participants about the  ability of the central bank to achieve its target. Regulation D’s definitions that define  reserveable liabilities for reserve requirements purposes in the United  States would not be needed and all costs and administrative burdens  associated with reserve requirements would be eliminated. CFPB did not provide comments on a draft  of this report. Appendix I: Objectives, Scope, and Methodology

The objectives of this report were to examine: (1) the purpose of reserve  requirements and Regulation D; (2) how depository institutions  implement Regulation D’s requirements and the effect of the regulation on  operations; (3) the effect on customers of the Regulation D transaction  limit on certain transfers and withdrawals from savings deposits; and (4)  foreign central banks’ varying dependence on reserve requirements and  the monetary policy implications. Finally, to  examine foreign central banks’ varying dependence on reserve  requirements and the monetary policy implications, we reviewed  academic literature and Federal Reserve publications on the role of  reserve requirements and other tools in conducting monetary policy,  recent innovations in the conduct of monetary policy that may change that  role, and other developed countries’ approaches to implementing  monetary policy. We obtained an  unweighted survey response rate of 71 percent. However, this objective was complicated in practice because  reserve requirement ratios were established in the Federal Reserve Act  and not by the Board of Governors of the Federal Reserve System (Board  of Governors) and by the reliance on the discount rate as the primary tool  for influencing the availability  and cost of money and credit at the time. By 1931, the Federal Reserve moved from using reserve requirements as  a source of liquidity for deposits held at depository institutions to using  reserve requirements to proactively affect the cost and availability  of  money and credit. While there are  consequences for reducing or eliminating reserve requirements on the  implementation of monetary policy, including potential short-term interest  rate volatility  and the cost associated with other frameworks, the corridor  operating frameworks in these and other counties also provide examples  of dealing with those consequences without reliance on the required  maintenance of reserves.
Why GAO Did This Study

Section 19 of the Federal Reserve Act requires depository institutions to maintain reserves against a portion of their transaction accounts solely for the implementation of monetary policy. Regulation D implements section 19, and it also requires institutions to limit certain kinds of transfers and withdrawals from savings deposits to not more than six per month or statement cycle if they wish to avoid having to maintain reserves against these accounts. The transaction limit allows the Federal Reserve to distinguish between transaction accounts and savings deposits for reserves purposes.
GAO was asked to review certain effects of Regulation D. This report's objectives include examining depository institutions' implementation of Regulation D's requirements, the effect of the transaction limit on their customers, and central banks' varying dependence on reserve requirements and the monetary policy implications.
To examine these issues, GAO conducted a generalizable survey of 892 depository institutions (with a response rate of 71 percent); analyzed consumer complaint data from federal financial regulators; reviewed federal statutes and regulations, Federal Reserve System publications, and academic literature; and interviewed regulatory agency officials, representatives from banking and credit union associations, and depository institutions selected based on institution type and size.
The Federal Reserve and other federal banking regulators provided technical comments on a draft of this report, which we incorporated as appropriate.

What GAO Found

The methods by which depository institutions can implement Regulation D (Reserve Requirements of Depository Institutions) include maintaining reserves against transaction accounts and enforcing a numeric transfer and withdrawal (transaction) limit for savings deposits if they wish to avoid classifying those accounts as reservable transaction accounts. GAO estimates that 70–78 percent of depository institutions limit savings deposit transactions. Other methods include automatically transferring balances from transaction (e.g., checking) accounts to savings deposits in order to reduce reserve requirements. Institutions may choose to maintain transaction account reserves against savings deposits to eliminate the need to enforce the transaction limit. But some institutions GAO surveyed indicated that they had operational burdens associated with monitoring and enforcing the transaction limit (for example, 63–73 percent cited challenges, such as creating forms and converting and closing accounts). Available data indicate that few customers exceeded or expressed concerns about the limit.
Monetary policy—actions taken to influence the availability and cost of money and credit (i.e., interest rates)—can be conducted with varying dependence on reserve requirements. While many central banks around the world use reserve requirements, some have reduced their reliance on them due, in part, to the associated cost and administrative burdens. GAO reviewed how different central banks rely on reserve requirements and found a wide range of frameworks, including those with: (1) different mandatory reserve requirements (as compared to the United States), (2) voluntary reserve requirements, and (3) no reserve requirements at all. For example, countries with different mandatory reserves frameworks require maintaining reserves against all deposits, which eliminate the need to impose limits on transfers and withdrawals from specific accounts. While the Board of Governors of the Federal Reserve System (Federal Reserve) has used reserve requirements to help achieve the interest rate targets it sets in the market for reserves (federal funds market), central banks of other developed countries such as Canada, Australia, Sweden, and Denmark, among others, do not rely on reserve requirements. Instead, they use interest rates under their direct control to restrict interest rates from moving outside of a targeted range (corridor operating approach).
The authority for the Federal Reserve to pay interest on reserves has reduced some of the costs associated with reserve requirements in the United States. One of the alternatives to the current reserve requirement framework that GAO examined would require legislative change to further reduce some of these costs and burdens. Other approaches, while proven feasible for some foreign central banks, have implications for the conduct of monetary policy (e.g., require the pursuit of a corridor operating approach). Given the differences in financial systems across the globe, it is unclear whether the practices used by other nations would translate to the United States. Moreover, lowering or eliminating reserve requirements would raise a number of operational and technical issues for monetary policy implementation. For example, lowering or eliminating reserve requirements could introduce the need to manage potential volatility in short-term interest rates. Therefore, minimizing the burdens associated with reserve requirements would have to be weighed against the costs and monetary policy implications of any alternative framework when considering changes.