Bernanke's Exit Stragegy: Term Deposits

The Federal Reserve wants to create a term deposit facility as part of so-called "exit strategies" as outlined by the chairman Ben Bernanke.

Fed proposes term deposits to drain excess bank reserves
(12/28/09 AFP via Google)

"WASHINGTON — The US Federal Reserve proposed Monday the creation of a term-deposit facility for banks to drain some of the more than 1.0 trillion dollars in excess reserves from the banking system.

"The Fed said it was seeking public comment on proposed amendments to the reserve requirements for institutions eligible to receive earnings on their accounts at Federal Reserve Banks.

""Under the proposal, the Federal Reserve banks would offer interest-bearing term deposits to eligible institutions through an auction mechanism," the central bank said in a statement.

""Term deposits would be one of several tools that the Federal Reserve could employ to drain reserves to support the effective implementation of monetary policy," it said.

"Institutions holding term deposits would "receive earnings at a rate that would not exceed the general level of short-term interest rates," according to the Fed proposal." [The article continues.]

Offering financial institutions interest-bearing term deposits is one of Ben Bernanke's "exit strategies". (For more, please read my post from July, when Bernanke outlined his thinking in Wall Street Journal.)

The Federal Reserve has been paying interest on the banks' excess reserves since October last year. All this term deposit facility will do is to lock up the excess reserves for a period of time, instead of having them as excess reserves (which is good as cash, a demand deposit).

According to the attachment to the Federal Reserve's press release today,

• Term deposits will be made available by auctions.
• No early withdrawal allowed.
• Term deposits will be open to the branches and agencies of foreign banks.
• Maturities will not exceed 1 year, with majority from 1 month to 6 months.
• Institutions can use term deposits as collateral for the Fed discount window.
• Term deposits would receive a zero risk-weight for risk-based capital purposes.

The facility may temporarily transfer the excess reserves into the term deposits at the Federal Reserve, but that will do nothing to shrink the size of the Fed's balance sheet. The term deposits will sit on the Liabilities side of the balance sheet, the same side as the excess reserves.

I find it ironic that the term deposits would receive a zero risk-weight when the Federal Reserve is loaded with agency bonds and mortgage backed securities. That's one advantage of being a central bank, who can print money and who is effectively backstopped by the government (i.e. taxpayers).

What if the financial institutions decline the offer and would rather take the money out of the excess reserves or keep the money in the excess reserves? I suppose that's why the Federal Reserve is seeking comments from the very institutions whom it wants to use this facility and help manage the excess reserves lest they spill over into the real economy (aka Main Street). It is asking the financial institutions what it will take for them to continue to park their money (excess reserves) with the Fed.

Well I have to say, regardless of whether this can be considered as an "exit strategy" (I personally think this should be called "kicking the can further down the road"), the existence of the excess reserves at the Fed is real, not fictional, and the Fed is scared enough of its inflationary implications.

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