The Federal Reserve announced they were reducing the reserve requirement ratio to zero percent across all deposit tiers as of March 26, 2020. This comes as the COVID-19 pandemic continues to impact much of the way financial institutions both operate and serve their customers.
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- Gary Smith | Eide Bailly’s Partner-in-Charge of Financial Institutions
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What Is the Reserve Requirement?
The Federal Reserve’s Regulation D has been around for years and requires depository institutions to keep enough cash reserves available to meet the immediate withdrawal requests of their net transaction accounts. The term used to describe these cash reserves is the reserve requirement.
Historically, the reserve requirement has been calculated by applying a predetermined tiered percentage (called the reserve requirement ratio) to the institution’s net transaction account balance. One way the calculated total can be satisfied is by having enough vault cash on hand. If the vault cash balance is insufficient, the institution is required to hold the additional funds in an interest-bearing account at a Reserve Bank. Historically, the reserve requirement ratios ranged from zero to 10 percent, based on the dollar amount of net transaction accounts held on deposit at the institution.
Why the Reserve Requirement is Important?
The Federal Reserve’s Reserve Requirement is essential for the stability of our economy as well as the financial security of individuals, families, businesses and financial institutions. Requiring banks to have a reserve requirement serves to protect them and their customers from a bank run. When the Fed adjusts the reserve requirement, it allows banks to charge lower interest rates, which in turn creates more appealing lending opportunities for those who need to borrow money—people who are financially impacted by the pandemic, business owners, homebuyers, college students, etc.
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What Does This Change Mean?
Depository institutions that were required to maintain deposits in a Reserve Bank account to satisfy reserve requirements will no longer be required to do so and can use the additional liquidity to lend to individuals and businesses.
According to the Federal Reserve website, there are currently no plans to reinstate the reserve requirement. However, they leave open the possibility of adjusting reserve requirement ratios if conditions warrant.
Some of the compliance and operational results of the change to reserve requirements include:
- The difference between transaction accounts and savings deposits is no longer relevant for reserve requirement purposes; presently, they both have zero reserves required. The distinction between the two does remain relevant, however, when filing the Report of Transaction Accounts, Other Deposits and Vault Cash (FR 2900).
- The FR 2900 report is a tool used to assist the Federal Reserve Board when making monetary policy decisions. Depository institutions record specific types of account balances and submit the report on a scheduled basis. The elimination of required reserves does not affect the submission of the FR 2900. Filing of the report continues to be required by depository institutions. The report will be completed using the same frequency and method that was utilized prior to the elimination of the reserve requirement.
- Because of the change to reserve requirements, depository institutions may allow customers to make more than six convenient transfers per month from their savings deposits (this includes both savings accounts and MMDA accounts). The caveat to this change is if your customers are allowed to exceed the transaction limitation, these account balances must be reclassified to transaction accounts when submitting the FR 2900 report.
- If your institution chooses not to reclassify your savings deposits for FR 2900 reporting purposes, you are required to continue to enforce the transfer limitations required by Regulation D.
- Before doing a mass change to reclassify your savings deposits, you should check your existing account agreements to determine if you have a responsibility to notify the customers of a change in terms.
- The Federal Reserve has stated that because the COVID-19 pandemic will cause some depository institutions to close branches or create customers who are in need of more convenient access to their funds, institutions should be willing to work with their customers.
- A suggestion stated on the Federal Reserve website, as a short-term solution, is to allow customers to conduct more than the six convenient transfers but then reclassify the accounts for FR 2900 purposes, as stated previously. A change in terms would need to be sent within 30 days of reclassifying the account.
- The increased need for cash or branches being closed may not affect your entire customer base during this crisis, so you can reclassify accounts on a customer-by-customer basis to give them some regulatory relief. This also gives your depository institution time to decide what long-term solution is best for your institution.
“Given the condition of the economy, in the early stages of the crisis it seemed plausible that, with a rapid, forceful, and sustained policy response, many sectors of the economy would be able to bounce back strongly once the virus was under control. That response would need to come from actions across all levels of government, from health and fiscal authorities, and from the Federal Reserve.”
- Chair Jerome H. Powell | Speech at the National Association for Business Economics Virtual Annual Meeting, October 06, 2020
The Importance of Compliance During COVID-19
While COVID-19 is impacting the way financial institutions operate, it is still important to maintain compliance. As guidance is issued and requirements are changed such as the reserve requirement, it’s important to understand what this means, not only for your financial institution, but for your customers. Take a look at the Federal Reserve Maintenance Manual.