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U.S. House of Representatives,
Committee on Banking and Financial Services,
Washington, DC.

    The committee met, pursuant to call, at 10:06 a.m., in room 2128, Rayburn House Office Building, Hon. James A. Leach, [chairman of the committee], presiding.

    Present: Chairman Leach; Representatives Roukema, Lazio, Metcalf, Kelly, Biggert, Terry, LaFalce, Waters, C. Maloney of New York, Watt, Bentsen, J. Maloney of Connecticut, Sherman, Mascara, Inslee, Schakowsky, Moore, Gonzalez, Jones, and Capuano.

    Chairman LEACH. The hearing will come to order. Today the committee meets to discuss issues related to authorizing the Federal Reserve System to pay interest in the sterile reserves that depository institutions are required to hold with the Fed.

    In this regard, our esteemed colleague from New York, Representative Sue Kelly, has introduced H.R. 4209, the Bank Reserves Modernization Act of 2000, with co-sponsorship from Representative Jack Metcalf of Washington, who has been a long-time supporter of this concept, and Representative Jim Maloney of Connecticut.

    This proposal has been considered several times in the past by this committee, usually in conjunction with legislation to allow banks to pay interest on business checking accounts. This year, the issues have been legislatively de-coupled, and last month the House approved, in a bipartisan vote, H.R. 4067, the Business Checking Modernization Act.
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    From the banking industry's perspective, the payment of interest on reserves appears on its face to be only fair. Banks would be allowed, like their customers, to collect interest on their savings. In addition, the Fed would be better able to manage monetary policy, because disincentives for holding funds at the Fed would be reduced.

    By way of background, the sole purpose for reserves, as clearly stated in the Federal Reserve Act, is a tool for implementation of monetary policy. The Federal Reserve Open Market Committee sets a target interest rate for the Fed's fund market, the market in which banks lend to each other. The statutory requirement to maintain reserves helps to ensure a stable, predictable demand for funds, and when the Federal Reserve affects interest rates by adjusting the supply funds available for meeting that demand through the New York Federal Reserve Bank's open market operations.

    Required reserves have been an integral part of how the Federal Reserve conducts monetary policy. However, because of the constraint imposed on the depository institutions in their ability to earn a return on assets they control, depository institutions have undertaken considerable effort to find methods to reduce their reserve requirements and have thus undercut this key monetary policy tool.

    As a result, required reserves held in Federal Reserve banks have dropped to $6 billion, from $28 billion, in only seven years. While many other countries do not employ reserve requirements, and use different tools for implementing monetary policy, the traditional American method appears to fit our system reasonably well.

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    Without this tool, there could be an increase in the volatility of interbank interest rates that could affect interest rates for the public. The door could be opened to proposals to provide the Fed with other mechanisms to implement monetary policy that could lead to uncertainty in the markets, particularly during periods Congress might be grappling with the issue. In fact, banks, credit unions and savings associations argue that the reserves they hold at the Federal Reserve banks amount to an interest-free loan to the Federal Government, and thus a tax.

    However, if reserves were not required to be held by these depository institutions, the Federal Reserve would have less in earnings to return to the Government. Authorizing the Federal Reserve to pay interest on sterile reserves thus carries a budget impact, although with the decline in reserves, it would not be nearly as great as would have been the case a decade ago.

    But this modest revenue loss, less than 1 percent of what the Fed turns over to the Treasury each year, would be counterbalanced by the enhanced ability to the Fed to effectuate a consistent monetary policy.

    The debate is then whether a policy that leads to modest revenues foregone is important to this country, its economy, its citizens, and its banking system, and whether, if a change in policy takes place, resources should come from the Fed surplus account, rather than implicitly from other programs.

    These are the issues the committee will have to review. At this point, let me ask Mr. LaFalce if he has an opening statement.
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    Mr. LAFALCE. Thank you very much, Mr. Chairman. The issue the committee addresses today has significant implications for the industry, the conduct of monetary policy by the Federal Reserve Board, and of course, the Federal budget. Although the committee in the House supported a repeal of the prohibition in the last Congress, as did I, it is important that our committee examine all the implications of such a repeal. As a part of the monetary policy control apparatus of the Federal Reserve, all the United States banks, thrifts and credit unions are legally required to hold reserves based on a percentage of their transaction deposits, primarily checking accounts and now account deposits, and current law prohibits the payment of interest on those reserves.

    The Federal Reserve maintains that recent declines in the money held by depository institutions in the Federal Reserve banks has complicated its open market operations. And they have testified that continuing declines in those reserves could eventually lead to volatility in the Federal funds rate, which could make the conduct of monetary policy more difficult. And to help to reverse the decline in reserves, the Federal Reserve proposes that Federal Reserve banks be permitted to pay interest on these so-called sterile reserves.

    I certainly understand the logic of their argument. And very understandably, many in the industry view the combination of required reserves and the inability to receive interest on those reserves as a de facto tax on the industry, and naturally, strongly support a repeal of the prohibition.

    In addition, industry supports repeal to help defray its potential increased costs that might result from paying interest on commercial checking accounts should that become law. Regrettably, though, paying interest on sterile reserves would come at a cost to the taxpayers. CBO and OMB have consistently determined that measures similar to H.R. 4209 would reduce revenues by more than $100 million per year. Preliminary indications from both organizations indicate that H.R. 4209 would have a similar impact on the budget.
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    As a result, discussion of this issue necessarily devolves into a discussion of budget priorities. In light of the budget impact, our committee needs to ask some questions of the proponents of repeal. First, is there a realistic way to offset the lost revenues without taking funds away from other programs in the committee's jurisdiction?

    Second, we need to know just how critical the repeal is to the conduct of monetary policy. The Federal Reserve has taken steps on its own to reduce volatility in the Federal funds rate. We need to understand the track record of these measures and explore what steps the Federal Reserve could take that do not implicate taxpayer funds.

    The committee must also understand who the repeal truly benefits and who it does not, which institutions would be the primary recipient of interest payments. Prior industry testimony has indicated that a repeal of the prohibition would primarily benefit the top one-fifth of U.S. institutions. Would consumers receive the benefit? There is nothing in the legislation that guarantees that the benefits of the interest payments will be passed on to the consumers. Perhaps there can be.

    Then, of course, you know, the final question is, despite all the arguments, is the equity of giving interest, or the inequity of not giving interest, so compelling, regardless of competing considerations, it should be passed simply for that reason alone? This hearing presents a good opportunity to hear the views of experts on monetary policy and related issues, and I am sure it will be helpful to our future considerations. Thank you.

    Chairman LEACH. Thank you, John.
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    Mrs. Roukema.

    Mrs. ROUKEMA. Yes, thank you. I have a short statement, Mr. Chairman. I appreciate your holding this hearing today. And despite what some may assert, this hearing today is about monetary policy and making sure that Chairman Greenspan and the Federal Reserve have the adequate tools to fine-tune the economy. I want to emphasize that in my opinion, it is not at all about paying big banks interest, or not funding or denying funding to domestic programs. It is about the economy and the onward growth of that economy.

    Some of our Members may remember that I have received testimony before my committee on at least two occasions in the last three years on this very subject. And in fact, we passed, in the House by voice vote in 1998, provisions to deal with this. I know that reserves are an important monetary policy tool, and we have recognized that in the past. I for one—I shouldn't say I for one, I believe we have all been pleased with how the economy has performed over the last eight years. Interest rates have been low, employment, growth have been high, and we are in the midst of the longest peacetime expansion on record.

    In my opinion, and I think as evidenced by most knowledgeable people in this country, the Federal Reserve has done a masterful job of negotiating during several financial crises, including the Asian flu of 1997 and 1998, and the Russian bond default and even Long-Term Capital Management and other problems. They have done a good job.

    Now, we know that reserves have dropped from $28 billion down to $6 billion. It is a reason for concern. The Federal Reserve's ability to keep the economy on track is what is at stake here. It is time for us to act. And Mr. Secretary, please don't take what I am about to say personally, all right? You agree with me? Don't take it personally. But I do want to quote a notable Democratic president, President Clinton, who, in his campaign, said, and I quote: ''It is the economy, stupid.''
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    I think that is what we have to focus on here as we look forward. I look forward to working with Treasury, with the Fed in dealing with the issue of monetary policy. I believe it is very serious, and I hope that we can work with the Administration in finding a solution and dealing realistically with the central issue and help the Fed out with this issue. It is not about a handout to big banks. It is about being able to manage the economy.

    Thank you very much, Mr. Chairman.

    Chairman LEACH. Does anyone else in the Democratic side seek to make an opening statement? If not, we first go to Mr. Metcalf.

    Mr. METCALF. Thank you, Mr. Chairman, for holding this hearing, and your strong support to authorize the payment of interest on reserve balances by the Federal Reserve. Reserve balances held by the Federal Reserve have dropped alarmingly from approximately $28 billion in 1993 to only about $6 billion today. I am very concerned that the dramatic reduction in reserves could adversely affect the Federal Reserve in conducting monetary policy. Congress should permit the Federal Reserve to pay interest on reserves and lessen the economic incentive for banks to introduce reserve avoidance measures. I am hopeful that this committee will be able to work with the Administration to finding a way to fix this problem and resolve the loss of revenues received by the Treasury from the Federal Reserve.

    Thank you, Mr. Chairman.

    Chairman LEACH. Now to the author of this particular bill, although it has also been part of a bill that Mr. Metcalf had authored for several Congresses, but leadership at this time falls to Mrs. Kelly. And please, if you have any comments, we would love to hear them.
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    Mrs. KELLY. Thank you, Mr. Chairman, Ranking Member LaFalce. I want to begin by thanking you both for agreeing to hold this hearing on my legislation today. I also want to thank Mr. Metcalf and Mr. Maloney for recognizing the importance of this legislation and agreeing to introduce it with me today. Finally, let me recognize Mr. Gonzalez, who is joining us as a strong co-sponsor of this legislation. This legislation would simply give the Federal Reserve the authority to pay interest on the reserve balances held at a Federal Reserve bank. This authority was contained in our regulatory relief package that passed the House of Congress last year and is in H.R. 1585, the Reg Relief bill, currently before the committee.

    It's my hope that through the testimony of the witnesses before us today, we can all gain a better understanding of the benefits that we will gain by granting the Fed this authority.

    With that knowledge, I would hope that this initiative could again be married with legislation that would allow banks to pay interest on commercial checking accounts. This provision is essential to offset the cost that the interest on commercial checking legislation will impose upon banks. We have heard this idea in this committee when Governor Meyer came before us last year. I hope he will expand on this concept today.

    Banks are currently able to meet their reserve requirements in three ways: The first is by holding the necessary money in their vaults where it loses value due to inflation. Second, by depositing it with a Federal Reserve bank, where again, it loses value due to inflation. Third, they can keep the money in a large network of ATM machines, there it goes to work for them. And hence, the big banks, with large ATM networks, do not have to effectively comply with this reserve requirement.
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    So who does this policy hurt? The small- to medium-size banks without large ATM networks. This policy effectively acts as a tax upon these small to medium banks, who are held at a disadvantage to the larger banks. Additionally, large banks have jumped through countless hoops to avoid holding their reserve requirements.

    I will explore this in greater detail with our witnesses, but it is clear that the enactment of this legislation will greatly simplify banking operations. This will allow banks to spend more time serving their customers rather than looking to avoid reserve requirements.

    Finally, proper reserves is simply sound economic policy that will assist the Federal Reserve to ensure a strong economy for years to come. While these requirements no longer serve the purpose of monetary control, they do play a valuable role in the implementation of monetary policy. And I will allow Governor Meyer to go into greater detail on that point, I hope he will.

    I do want to thank all of our witnesses for taking the time to join us today to share their views with us. I look forward to discussing these issues with all of you and hope that by the end of the hearing, additional Members of this committee will join us in the support for this legislation.

    Thank you, Mr. Chairman. I yield back the balance of my time.

    Chairman LEACH. Thank you very much, Mrs. Kelly.
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    Does anyone else seek to make comments? If not, I would like to turn to our distinguished Under Secretary for Domestic Finance at the Department of the Treasury, Mr. Gary Gensler.

    Gary, welcome back to the committee. And please proceed as you see fit.


    Mr. GENSLER. Thank you, Mr. Chairman, Ranking Member LaFalce, and all the Members of the committee. And I would say, Congresswoman Roukema, I am honored any time you quote President Clinton. So I took it as it was meant. I appreciate this opportunity to present the Administration's view on Congresswoman Kelly's bill, H.R. 4209. If I could ask permission to submit my testimony for the record, I will try to summarize.

    Chairman LEACH. Without objection, both yours and Governor Meyer's testimony will be, in full, submitted for the record.

    Proceed as you see fit.

    Mr. GENSLER. As noted, the bill would permit the payment of interest on reserves by the Federal Reserve on the reserve balances that banks maintain in Federal Reserve banks. Just as a bit of background, and I think that all of the Members are familiar with this, the Federal Reserve Act requires depository institutions to maintain reserves against certain of their deposit liabilities.
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    This has evolved over time, but currently the Federal Reserve sets reserve requirements above zero on transaction balances in excess of approximately $5 million, and actually sets a zero reserve on many other balances.

    Thus, as one looks at the whole system, the Federal Reserve sets a reserve requirement on just a little under one-quarter of the total deposits in the banking system today. These reserve requirements are typically met by vault cash, as was noted. In fact, the vast majority, about 85 percent of the reserve requirements today, are met by vault cash. In excess of that vault cash, reserve requirements are also met with deposits at the Federal Reserve directly. And I think that that is what the debate and what the bill really raises—the ability to pay interest on required reserves in excess of the vault cash, and also the possibility of paying interest on reserves that are held in excess of the required amount.

    As has been noted, the required balances have been declining dramatically in the last ten years. Today, or as of the end of March, there was about $38 billion of requirements met by $33 billion of vault cash, so there are only about $5- or $5.5-billion of required reserves today and that may change over time. And as we said, that has dropped dramatically from a balance of ten years ago of about $34 billion.

    There are several reasons these declines have occurred. I know Governor Meyer will be more specific on that. Part of it is that regulation has changed and the Federal Reserve is actually applying the requirements to fewer balances. But beyond that, the banks have used a growing technology known as ''sweep'' accounts. Sweep accounts provide the ability to sweep money out of non-interest-bearing accounts and then invest it in interest-earning accounts.
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    There are three reasons that we have heard that proponents put forward for the payment of interest on reserves, and they have all been highlighted here. If I could summarize. First, economic efficiency; second, monetary policy; and third, the cost of the banking industry itself.

    In terms of economic efficiency, the logic is clear that some banks are using sweep accounts today to avoid the reserve requirement. Sweep accounts, by and of themselves, are a natural part of the financial market. They actually came up and grew for other reasons, and were used in commercial transactions. But more and more, they are being used by banks for retail accounts for smaller depositors, to avoid reserve requirements.

    Now, again, reserve requirements are only on an institution's aggregate transaction accounts over $5 million. But there may be some efficiency if banks were no longer seeking to do these sweep accounts and the economics around that.

    Quite possibly the more significant reason that has been raised, and I know that Governor Meyer will be speaking to this issue, is monetary policy. The belief that the decline in these reserve balances as they have come down from $30 billion to approximately $5 billion, and may decline in the future as technology facilitates even more sweep accounts, that that decline in reserve balances may lead to increased volatility in short-term interest rates. The Federal Reserve seeks to manage monetary affairs through the management of short-term interest rates. And if volatility of short-term interest rates were to increase, that is of concern to the Federal Reserve.

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    Declining balances today have not yet evidenced this behavior of higher volatility. But again, the Federal Reserve has made other adjustments, and it is hard to determine, probably for any of us, precisely what the future would hold if the balances declined further. But the concern at its core is that less reserve requirements may lead to higher volatility and diminish the ability of the Federal Reserve to manage around that volatility.

    The third area that is raised is the cost to the banking industry. The Congressional Budget Office estimates that payment of interest on reserves would cost $600- or $700-million to the taxpayers over five years. The reverse of this is that the banking industry today is not being paid, in essence, that money, between $100- and $200-million in the first year, and various estimates over the five-year period.

    So banks have long contended that the cost of reserve requirements and foregone earnings is a cost to them, a competitive disadvantage versus the mutual fund industry, or the security industry and so forth. Others observe, probably rightly, that there is a multifaceted relationship between banks and the Federal Government. There is deposit insurance, there is access to the Federal Reserve discount window, there is access to the payment system.

    And so that one looking at the various costs and benefits of being a federally-regulated bank, one would certainly put this as a cost, not being paid interest on reserve balances, but there are also various benefits. And I know that around financial modernization, there was a great deal of discussion and debate about the potential cost and benefits and even possible subsidies of the banking system.

    I think the core of Treasury's concerns about this bill, while we share many of these observations, particularly around monetary policy, is the numbers raised by the Office of Management and Budget and the Congressional Budget Office, estimates of between $600- and $700-million over five years. These estimates do take into consideration the offsetting tax receipts that the Treasury would receive. If interest is paid to banks, it has been forecasted that Treasury would earn some tax revenues back. The estimates take into consideration some offsets related to the potential increase in these reserves. The estimates appear to have been done rigorously, and by two offices, both yours in the CBO and ours in the OMB.
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    So in conclusion, proponents of paying interest on reserve balances have put forth a number of reasons. As you will hear, certainly from Governor Meyer, the ability to pay interest on these balances may improve the effectiveness of the tools that the Federal Reserve has to implement monetary policy. And the Federal Reserve and others have also suggested these various efficiencies that could come from lessening the use of sweep accounts.

    As a matter of appropriate monetary control paying interest on reserves in our opinion might be a step in the right direction. However, the use of taxpayer resources in this regard is not contained in the President's budget, and since paying interest on reserves would cost taxpayers $600- to $700-million over five years, we would strongly believe that this must not be done at the at the expense of other priorities. With that, we thank you for the opportunity to testify and look forward to any questions.

    Chairman LEACH. Thank you, Mr. Secretary.

    Our second witness is the Honorable Lawrence Meyer, who is a Governor of the Federal Reserve Board. You are welcome.


    Mr. MEYER. Thank you, Mr. Chairman, Congressman LaFalce and Members of the committee. The Board of Governors appreciates this opportunity to comment on the issues related to H.R. 4209, the Bank Reserves Modernization Act of 2000.
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    The Board strongly supports the proposal in this bill to allow the payment of interest on the balances that depository institutions maintain at Federal Reserve Banks. We have commented favorably on such proposals on a number of occasions over the years, and our reasons for that position still hold today.

    Historically, the issue of permitting interest to be paid on reserve balances has been linked to the repeal of the prohibition of interest on demand deposits. The Board is pleased that the House of Representatives has passed legislation that would ultimately permit the payment of interest on demand deposits. Assuming it becomes law, that legislation eventually will contribute considerably to the improved efficiency of our financial sector. Authorizing the Federal Reserve to pay interest on the balances that depository institutions hold at Federal Reserve Banks to meet reserve requirements would also increase the economic efficiency of our banking system.

    Depository institutions currently expend considerable resources to minimize their required reserve balances by developing and operating various programs, such as business and retail sweep programs, in order to minimize the balances recorded in their transaction accounts. From society's point of view, these expenditures are wasteful. Paying interest on required reserve balances would reduce depository institutions' incentives to engage in these practices.

    In light of the resources used by depository institutions to try to circumvent reserve requirements, some might question the reason for having such requirements. Indeed, reserve requirements have been eliminated in several other industrial countries. In the United States, reserve requirements remain useful as a tool of monetary policy by helping the Federal Reserve keep the Federal funds rate close to the target rate set by the Federal Open Market Committee. They do so in part by making the demand for reserve balances more predictable. Also, because required reserve balances must be maintained only on an average basis over a two-week period, depositories can adjust their daily reserve holding in a way that helps stabilize the Federal funds rate.
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    Because of reserve avoidance procedures, such as sweep programs, required reserve balances have fallen to a very low level. Steps taken by depository institutions and the Federal Reserve have offset tendencies for the Federal funds rate to become more volatile, because of the lower reserve balances. However, further increases in such reserve avoidance practices would increase the risk of heightened volatility in the Federal funds rate. Payment of interest on required reserve balances could eliminate the incentive to engage in reserve avoidance practices and the associated risk of greater volatility in the Federal funds rate.

    The proposed legislation would allow interest to be paid on required reserve balances and also on two other types of balances that depositories hold in Federal Reserve Banks, required clearing balances and excess reserves. Required clearing balances already earn implicit interest that the depositories use to offset charges for Federal Reserve services. Because required clearing balances are based on two-week averages, contracted in advance by depository institutions, they also help to stabilize the Federal funds rate in a manner similar to required reserve balances. Payment of explicit interest on these balances could result in an increase in their level and in their usefulness for monetary policy implementation.

    Excess reserve balances are held by depository institutions as a precaution against reserve requirement deficiencies or overnight overdrafts. If the Federal Reserve paid interest on excess reserve balances, that interest rate would tend to act as a floor on the Federal funds rate. Because banks would not likely lend to private banks at a rate lower than they could earn on excess reserves, it would be useful for the Federal Reserve to have the ability to pay interest on excess reserves. While this monetary policy tool might not need to be employed, it would also help to over stabilize overnight interest rates, if needed, as other central banks have found.
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    While interest on required clearing and excess reserves would not likely imply net costs for the Federal budget, interest on required reserve balances would involve a net budgetary outlay. This committee has requested the Board's view on the possibility of transferring some of the capital surplus of the Federal Reserve Banks to the Treasury in order to cover the budgetary costs of paying interest on required reserve balances. While the Federal Reserve pays nearly all its earnings to the Treasury on a weekly basis, it sets aside a portion of its earnings to allow its surplus account to rise in line with the increase in paid-in capital that is contributed by member banks.

    A transfer of the Federal Reserve's surplus to Treasury would technically increase reported budget receipts owing to a unified budget convention, but would not represent a true source of revenue for the Treasury. The transfer would allow the Treasury to avoid selling some debt to the public. However, to maintain the standards of monetary policy while making the transfer, the Federal Reserve would have to sell some of its Treasury securities to the public. Thus, the net amount of Treasury debt held by the public would be the same either with or without the transfer.

    As noted in the Congressional Budget Resolutions in 1996, 1997, and again this year, transfers of surplus have no real budgetary or economic effects. As my written testimony describes in more detail, one reason for a sizable Federal Reserve surplus account has traditionally been the extra backing that it allows for the issuance of currency. However, legislation signed into law last year expanded the range of assets of the Federal Reserve that could serve as collateral for the issuance of currency. As a result, the importance of the surplus in helping to provide a margin of excess currency collateral has greatly diminished.
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    Traditionally, the Federal Reserve, like other central banks, has maintained an appreciable level of capital, including its surplus account. Ensuring that assets remain comfortably in excess of liabilities may help support the perception of a central bank as a stable and independent institution. However, creditors of central banks are at no risk of a loss because the central bank can always create additional currency to meet any obligation. Moreover, the Federal Reserve's need for capital is limited by the modest variability of its profits, the safety of its primary asset, Treasury securities, and the substantial regular flow of earnings from its portfolio of securities.

    Whatever the benefits of the Federal Reserve surplus, it should be emphasized that its maintenance is costless to the Treasury and to the taxpayers. Thank you.

    Chairman LEACH. Thank you very much. I have no questions.

    I would like to at this point, though, particularly express my appreciation to Secretary Gensler for a very balanced perspective from the Treasury, one that I read as being very open to change, although recognizing that there are some downsides that should be compensated for.

    In any regard, I want to thank you very much.

    Mr. LaFalce.

    Mr. LAFALCE. Thank you, Mr. Chairman.
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    Mr. Gensler, I read your testimony similar to the reading of Mr. Leach that ''Treasury is unable to support the bill,'' those are your exact words, but not that you oppose the bill. Your primary concern is the cost that you estimate and other priorities and where they would be on a relative scale. Is that reading correct?

    Mr. GENSLER. I think both the Chairman's and Congressman LaFalce's read is correct that while we have an understanding—and I think it is an understanding that is close to many of the Members' statements and Governor Meyer'—about the possibility, long term, about the monetary affairs, that the issue for this bill in front of the Congress is how one sets priorities. In the Administration's budget and the President's budget, this was not part of those proposals.

    Mr. LAFALCE. All right. Fine. There was one possible discrepancy—perhaps not—in your testimony, and it had to do with the last sentence of Dr. Meyer's statement when you said, ''payment of interest would be costless, it wouldn't cost the taxpayers anything.'' I think that is what you said.

    Mr. MEYER. No. I said that the maintenance of the surplus is costless to the taxpayers. But we quite agree that the payment of interest on reserves would be costly, as the Under Secretary indicated.

    Mr. LAFALCE. All right. That is my mistake. We can make all these technical arguments, and I view them as not unimportant, but still technical. The principal difficulty I would have in opposing the bill would appear to me to be an inequity.
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    How can we say there is equity in denying interest on reserves, especially if we want to repeal the prohibition of interest on business checking accounts?

    Mr. Gensler.

    Mr. GENSLER. While there are three reasons that proponents of the bill put forward—and Treasury has some very real appreciation, and more than appreciation, agreement, on the monetary policy point—the one that we think it is important to look at in the overall relationship of banks with the Federal Government is the cost. There were many in the very real debate that this committee and the Congress had on financial modernization last year that thought, on a net basis, banks actually received more than it cost.

    Mr. LAFALCE. I want to come back to the question of cost. But before I do that, I want to focus in on the question of equity or inequity to those institutions who have reserves mandated by law and who are not able to obtain interest on that. It does appear inequitable to me. Does it appear inequitable to you? Do you answer that by the offsetting benefits?

    Mr. GENSLER. Again, we look at it—and there are many relationships that banks have. Currently, over 90 percent of banks do not pay for deposit insurance. Banks can get funds at the discount window from the Federal Reserve; such funds are not available to others. So there are many benefits banks also get, and this committee looks at those from time to time.

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    Mr. LAFALCE. Sure. That was one of the arguments of the Federal Reserve that there are subsides that are given and that is why they had difficulties with the operating subsidiary.

    Mr. GENSLER. Right.

    Mr. LAFALCE. Dr. Meyer, let me flip and let me now go to the subsidy argument; that is history now.

    Mr. MEYER. Thank you.

    Mr. GENSLER. We thank you from the Treasury also.

    Mr. LAFALCE. Good. Let me flip; and arguing the inequity of not paying reserves, there are many inequities in life. There are many inequities that there are still so many homeless in our society for which we have jurisdiction; there are inequities that we have not been able to give full relief to the Third World that we would like to, and so forth. So going to Mr. Gensler's theme of priorities, I think removing the inequity of not paying interest for the business checking account is a higher priority than paying interest to the banks on their sterile reserves.

    Why should we deal with the inequity of not paying interest on sterile reserves when we are so unable to deal with the inequity of homeless Americans living in terrible shelter, or we are unable to deal fully with the problems of the Third World countries, and so forth, and so forth? Again, this goes to the question of relative priorities.
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    Mr. MEYER. Right. What I can do is help this committee understand the value for public policy purposes of paying interest on reserves. The fact that it would increase efficiency, avoid wasteful spending in the economy, the fact that it would facilitate a more effective monetary policy. And I can confirm the cost estimates of what it will cost to get the job done.

    Now, I really am not in a position to balance the benefits from this legislation against other programs that might have to be sacrificed in order to pay those expenses. I don't believe that you would want me to come in here and go through that exercise. I wasn't elected to do that and you were.

    Mr. LAFALCE. I just wanted to raise the issue.

    Mr. MEYER. I understand that it is an issue.

    I might just add one additional point. It has never been more timely to proceed with this legislation. And it has never been cheaper to get the job done. It has never been more timely, because the required reserve balances have now fallen to a little below $5.5 billion. We think by the end of the year they will be around $4.5 billion, by the end of next year $4 billion. We are getting to an area of heightened risk of increased volatility in the Federal funds rate.

    Now it is a risk. I can't guarantee you if we got to that range we would really see that, but it is a risk. So in that sense, I don't want to use the word ''urgency'' because I can't be sure that we will face that heightened interest rate volatility, but certainly it has never been more timely. In other times when we have testified on behalf of this legislation, often the cost would have been $2 billion a year, now it is getting down to $100 million a year, but it is still a cost.
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    Mr. LAFALCE. Another argument to the argument of equity is the argument of prudence.

    Mr. MEYER. Thank you.

    Mr. LAFALCE. Thank you.

    Chairman LEACH. Mrs. Roukema.

    Mrs. ROUKEMA. Thank you, Mr. Chairman.

    Governor Meyer, in a sense, you answered the question I was going to present to you. I wanted you to elaborate on what the consequences to the economy are if the Federal Reserve doesn't have sufficient reserves. I won't go over that again. I will simply observe—and, Mr. Gensler, I heard you, but I can't agree with you about the tradeoff—that the central issue is what domestic programs will be impacted negatively. The point I think that Governor Meyer has made so well is that without adequate reserves, the negative impact on the economy could be and undoubtedly will be far greater. It doesn't matter whether it is more people in homeless shelters or other negative economic consequences to the economy at large, the lack of adequate reserves may hurt the Fed's ability to effectively manage the economy. And if you want to elaborate on that, fine. Otherwise, let your statement stand.

    But I must simply say that I heard, and I hope this committee has heard, and certainly we will repeat it to the Congress about it has never been more timely to deal with this question of the reserve balances, that there is a negative impact on domestic policy if we don't. Failure to act will have economic consequences and consequences in terms of how we have to increase spending on other domestic policies.
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    So thank you, Governor Meyer, if you want to make a further statement.

    Mr. MEYER. No. That covers the ground very well.

    Mrs. ROUKEMA. Thank you.

    Chairman LEACH. Mr. Mascara.

    Mr. MASCARA. I have no comments. Thank you.

    Chairman LEACH. Mr. Inslee.

    Mr. INSLEE. No, thank you, Mr. Chairman.

    Chairman LEACH. Mr. Moore.

    Mr. MOORE. No, thank you.

    Chairman LEACH. Co-sponsor of the legislation, Mr. Gonzalez.

    Mr. GONZALEZ. No questions. Thank you.

    Chairman LEACH. Mrs. Jones.

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    Mrs. JONES. No questions. Good morning.

    Chairman LEACH. Mr. Capuano.

    Mr. CAPUANO. Nothing.

    Chairman LEACH. Mr. Metcalf.

    Mr. METCALF. No questions.

    Chairman LEACH. Mrs. Kelly.

    Mrs. KELLY. Well, I do have some questions, Mr. Chairman.

    Chairman LEACH. Please.

    Mrs. KELLY. Governor Meyer, could you elaborate on some of the things that the banks are doing today to avoid holding proper reserves? I listed a couple of them; I am sure you know more. Would you be willing to do that?

    Mr. MEYER. Sure.

    There are two basic ways in which banks have reduced their required reserve balances: One, for their business customers, beginning in the 1970's, they began to take these balances and put them into open market assets, money market funds, repurchase agreements, and so forth, until they were needed.
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    But the more dramatic developments have occurred with retail sweep programs that began in January of 1994. And in these programs the banks take balances in NOW accounts or in demand deposits. And they come up with a target for these balances and anything above that target they sweep into non-reservable money market deposit accounts. And then when the balances in the checking account fall to zero, then they return money from the money market deposit account into the checking account up to the target and play this game all over again. And they can transfer six times back from the money market deposit accounts. And by doing that, they can reduce the average deposits in those accounts by 85 percent for NOW accounts and almost half for demand deposit accounts.

    And over the years they have reduced those transaction balances by $380 billion through these retail sweep accounts. So it has been a very, very effective program, and that is the main reason why we have seen this decline in required reserve balances from $28 billion at the end of 1993 to about $5.5 billion today.

    Mrs. KELLY. Without the authority, isn't the reserve requirement an implicit tax on assets?

    Mr. MEYER. Well, it is often viewed as a tax on the banking system, because it requires them to hold assets that don't earn any interest. And that is the sense in which it is a tax.

    Mrs. KELLY. I think it would be helpful for us if you would describe what the Fed does with the reserve that it holds and whether or not the money earns interest.
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    Mr. MEYER. Well, when banks hold reserves, that is backed by securities that are held in the Federal Reserve's portfolio, which of course do earn interest.

    Mrs. KELLY. So you do earn interest on the reserves?

    Mr. MEYER. Absolutely.

    Mrs. KELLY. Mr. Gensler, I have been reading in your testimony and you testified today that you believe that there would be a cost to the taxpayers of $600 million to $700 million over five years. Do you recognize that while there may be a high initial cost, that the cost, in fact, declines over time?

    Mr. GENSLER. Both the Office of Management and Budget and CBO have studied this, and they have taken into consideration various aspects of it. It does, in OMB's estimates, start at about $160 million a year, and then in 2003 to 2005 stabilize around $100 million a year.

    Mrs. KELLY. So it does decline over time?

    Mr. GENSLER. Decline, and then it looks like it is about $100 million a year starting in the third to fifth year.

    Mrs. KELLY. Because in your testimony the only negative you spoke about was the cost of the proposal. I just needed to understand, are you saying that the benefits of this are not cost effective?
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    Mr. GENSLER. No, I think that we recognize some of the benefits, primarily the benefits around monetary policy, but are unable to lend support in that it will take, over this five-year period, the numbers we talked about, $600-or-so million, and that is from the taxpayers to the banking industry at a time when the banking industry is strong, but also at a time, as Congressman LaFalce said, when there are other priorities that the Administration is looking at in terms of scarce budget resources.

    Mrs. KELLY. And has the Administration looked at the value of a strong economy? Have they put that into the equation?

    Mr. GENSLER. Very much so, Congresswoman, and it is very much a hallmark of this Administration in working with this Congress in terms of promoting fiscal discipline, promoting a strong economy. So very much so.

    Mrs. KELLY. Well, don't you think that this will help keep a strong economy? I think I understood Governor Meyer to indicate that; did I not, Governor Meyer?

    Mr. MEYER. Yes, this would be a help in maintaining the effectiveness of monetary policy.

    Mr. GENSLER. It is, in a sense, what I think the Administration is saying is not only about priorities, but who bears that cost, is it the taxpayers that bear the cost, how it will work maybe with the banking industry. I don't think there are any amongst us that are saying there are not some potential benefits of the tool kit that the Federal Reserve has when it does its day-to-day work.
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    Mrs. KELLY. Yes, and it is that benefit that I wanted to focus on.

    Thank you very much, Mr. Chairman.

    Chairman LEACH. Thank you, Mrs. Kelly.

    Another co-sponsor, the gentleman from Connecticut, Mr. Maloney.

    Mr. MALONEY. No questions.

    Chairman LEACH. Thank you.

    Mr. GONZALEZ. Mr. Chairman, I do have a question.

    Chairman LEACH. You are recognized, Mr. Gonzalez.

    Mr. GONZALEZ. I guess it is to Mr. Gensler.

    I am trying to think in terms of analogies all the time and not necessarily think of banking institutions as anything different than people. I remember when my mortgage company would keep the monies to pay taxes and insurance. They keep it the entire year, and they use it, earn interest on it, just like the Government uses this particular money without really paying any interest on it.
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    Lo and behold, there was a hue and cry. Now I get to keep that money. I bear that interest. I invest it, and yet I still pay.

    Now, you have indicated there is some justification maybe, and I am trying to see if it is called implicit interest through the offset of fees, that maybe that is the benefit that is derived, not necessarily the fact that they get to derive interest from it, but they derive some benefit from it.

    I guess I did miss some of your testimony and I apologize, but if you could elaborate on the justification for not paying interest, that, on its face, would make a good argument that interest should be paid.

    Mr. GENSLER. In the testimony, what we said is that there are a number of benefits that have been highlighted, in particular, the one that we have greatest appreciation for is the effectiveness of the tool kit that the Federal Reserve might bring to bear on a regular basis. But we recognize also it costs taxpayers to move forward with this in the order of $600 million over five years and has not been in a list of priorities that the President forwarded to Congress. It would be in our minds a transfer from taxpayers to the banking industry while the banking industry is strong. As we look at this, that is what we were talking about.

    In terms of the technical question you asked, in fact, I think that was a reference only on something called clearing balances where they earn implied interest. On the required reserves, they do not earn interest, and I think that factually, we all accept that.

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    Mr. GONZALEZ. For every action, there is a reaction. I definitely did not originate that, did I? So everything we do here has some consequence fiscally. So is it a matter of timing? Is it something you think should be delayed and never advanced, simply because the President's budget—or whoever is putting things together at this time—has not factored that in? Or is it just simply, again, is it timing or is there something fundamentally wrong with the notion that these funds should bear interest?

    Mr. GENSLER. From the Administration's perspective, again, it is a question of priorities. Most certainly Congress sorts through its priorities, and must sort through this amongst the many priorities. But for the Administration, there are more significant priorities in terms of spending scarce budget resources.

    Mr. GONZALEZ. Thank you very much.

    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you, Mr. Gonzalez.

    Mrs. Biggert.

    Mrs. BIGGERT. Thank you, Mr. Chairman.

    Mr. Meyer, in your testimony you mentioned that some industrial countries have managed to implement monetary policy successfully without reserve requirements, specifically by using alternative procedures for implementing their policies. Can you elaborate to the committee on some of the alternative methods and why you believe that H.R. 4209 is the more preferable course than those other alternatives?
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    Mr. MEYER. Yes. That is an excellent question, because if this legislation doesn't pass, then we have to be prepared to think about alternative operating procedures, and how these countries operate provide us some options.

    These countries face the potential problem of volatility in their equivalent of the Federal funds rate, their overnight rate. What they have generally done is set up a corridor for interest rates by having some ceiling rate and some floor rate. The ceiling rate is usually based on what is called a Lombard facility, like a discount window, but with loans at a penalty rate. Our experience is that the ceiling would be between 25 basis points and 200 basis points above the overnight rate, and then there would be a floor set by the interest paid on excess reserves, typically 25 to 100 basis points below.

    So that corridor could be 50 basis points, or it could be 200 basis points or more. That is the procedure that is used in most of the cases to contain interest rate volatility. If this legislation doesn't pass and if we encounter increased interest rate volatility, then we would have to make some substantial changes in our operating procedures. We might have to change the way we operate the discount window, and we would very much need to come back to the committee at that point and get the authority to pay interest on excess reserves, because that would be a critical aspect of setting the floor.

    Mrs. BIGGERT. Thank you.

    Mr. MEYER. Could I just say one thing? It seems to me that we don't know for sure whether we will encounter that volatility, but I am quite confident that if this legislation doesn't pass and we find ourselves in an uncomfortable situation where we do get increased volatility and we have to move quickly to change our operating procedures, I think we will all come to regret that we didn't pay a rather small sum, I think, to have put in place a system which ensured that we could maintain the effectiveness of our current operating procedures.
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    Mrs. BIGGERT. Do you agree with the Congressional Budget Office from their analysis in February of 1999 that estimated the cost of the Fed payment of interest on the reserves at $661 million?

    Mr. MEYER. Yes. Of course there have been some changes. In the meantime, required reserve balances are lower than at the time they made that estimate, but interest rates are higher. Those two things about wash out. So we are in that ballpark still.

    Mrs. BIGGERT. Do you think there is any merit in waiting to see the impact of the Business Checking Modernization Act on the volume of receivable transaction accounts before proceeding with this legislation?

    Mr. MEYER. No, I don't believe so. That legislation itself, paying interest, the repeal of the prohibition of interest on demand deposits?

    Mrs. BIGGERT. Yes.

    Mr. MEYER. Without paying interest on required reserve balances, that legislation wouldn't have any impact in preventing a further decline in required reserve balances in our view.

    Mrs. BIGGERT. Mr. Gensler, it just sounds like if this legislation were to be passed, and then would be in the future, then as long as this was accounted for in the President's budget, would you then have the same opposition to the legislation?
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    Mr. GENSLER. I think, as we said, we are unable to support it, just to put it on the record.

    Mrs. BIGGERT. You would not be able to support it, then.

    Mr. GENSLER. It is a cost to taxpayers. It is a question of priorities for the Congress as to how to spend their scarce resources. It is also, I think, an interplay with the banking industry itself, because as we said in the testimony, there are not only costs that we all recognize as the costs, there are also various benefits, and the cost-benefit balance, too.

    Mrs. BIGGERT. Thank you.

    Thank you, Mr. Chairman.

    Chairman LEACH. Ms. Waters, did you seek recognition?

    Ms. WATERS. Thank you very much, Mr. Chairman.

    I am sorry that I could not be here at the opening of this hearing. I would like to thank our guests for being here. Mr. Gensler, I want you to know this is a much calmer and cooler hearing than when you were last here. I hope that you will leave here feeling a little bit better about being here than you did the last time.

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    Mr. GENSLER. I always feel very good being with this committee.

    Ms. WATERS. We are glad to see you. Let me raise some very basic questions. I will start with Mr. Meyer.

    If this bill is designed to increase the amount of reserves at the Federal Reserve that is kept so that they could have a better handle on influencing interest rates, and so forth, I would like to understand that a little bit better. Maybe you can tell me, is that the main focus? Is that the main reason why the Federal Reserve would like to have the ability to pay interest rates, they think they will be able to attract more money on reserve?

    Mr. MEYER. I think there are two reasons: One reason is it would increase the efficiency of the banking sector. Right now banks engage in a lot of wasteful spending to set up sweep programs to reduce their required reserve balances. Those are socially totally unproductive. They are simply an attempt to evade the reserve requirements, to avoid reserve requirements. So that would be socially useful to avoid that spending.

    The second reason that this legislation would be important is that it would ensure that the current operating procedures for monetary policy would remain effective. The reason that that would be the case is that with an appropriate level of required reserve balances, there is a more stable demand function for reserves.

    When we set a target for the Federal funds rate, we have to come up with a level of reserves to put in the market that will result in the supply and demand in that market achieving that target rate. To figure out how much reserves we have to put into that market, we have to have some understanding of what that demand function looks like. That demand function is much more stable at a higher level of reserve balances. When it falls to very low levels, it is dominated by daily clearing needs of banks which are highly volatile and that makes it very difficult for us to estimate just how much reserves we have to put into the banking system. And on any given day, we might not get it right and the actual Federal funds rate could deviate significantly from that target rate.
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    That increased volatility will make it more difficult for participants in the Federal funds market to make their decisions. It will increase the risks of the funding activities for the banks that are buying those reserves and it will also increase the uncertainty of the small banks who are selling the reserves in that market.

    Ms. WATERS. However, this is more about attracting reserve amounts from large banks rather than small ones, because you have exemptions for very small banks, and so forth. So this is really about the relationship of the larger banks to the Federal Reserve as it relates to the reserves possibilities.

    Mr. MEYER. One could look at the distribution, and it is true that a lot of smaller banks are exempt from reserve requirements, or pay smaller reserve requirements, because of the lower marginal rate up to $44 million. But this is not about small banks or large banks; this is about the ability of the Federal Reserve to hit its Federal Reserve funds target and conduct monetary policy.

    Ms. WATERS. Some would suggest that for some study that I happened to glance, that the relationship is not as profound, perhaps, as you are describing in terms of dictating what is happening in the marketplace. Let me just ask, what is the value to the consumers? For example, let me tell you what I would like the value to be. Consumers have been charged increasing fees by the banks. As a matter of fact, I think there is some information that will show that banks are now counting on a portion of their profits from the escalating fees that they are charging. If, in fact, banks are going to get interest on their reserves that they have not been receiving before, this is an infusion of dollars or cash that would allow them, perhaps, to reduce those fees to the consumer. There is, and if my analysis of this is correct, would you support, because there is an increased infusion of cash to banks that they didn't have before that this money could be used to reduce some of the fees that they are charging to their consumers?
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    Mr. MEYER. That is possible, but this will be determined by the markets and by the competition in the marketplace. To some extent this interest will be passed through, for example, in terms of higher interest on the transaction deposits—that would be one possible use of it. There are a whole variety of ways in which the interest that the banks earn could affect their customers. We wouldn't give them any direction as to how to use those interest earnings. The market would determine to what extent they were passed on to customers in the form of higher interest rates, the extent to which they might affect the fees that banks otherwise charge to their customers.

    Ms. WATERS. Would you as we consider this, take a look at in what ways it could be beneficial to consumers and share that information with those of us who are very concerned about benefits to consumers when we have these kinds of discussions?

    Mr. MEYER. Right. I think the most likely would be that we would see a small increase in the interest rate that consumers now earn on their NOW accounts, on their interest-bearing checking accounts.

    Ms. WATERS. Could we get some kind of analysis to compare a projected small increase in interest rates to the fees that customers are being charged to see if we can make a case for a reduction in fees?

    Mr. MEYER. I will look into it. But we do not make a case to banks about how they should price their services. I am really reluctant to get started down that road.
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    Ms. WATERS. Unanimous consent for just 30 seconds.

    Chairman LEACH. Yes, of course.

    Ms. WATERS. Thank you. And I have an appreciation for that, except the Federal Reserve would receive what they perceive as a real benefit if you are able to pay interest rates. So you have a vested interest in seeing that this is done.

    Mr. MEYER. Absolutely.

    Ms. WATERS. I guess what I am trying to say in a very nice way is some of us have a vested interest in making sure that the consumers benefit from it, and as we go through these discussions, perhaps if you can see our point of view, we can see your point of view, it would be helpful.

    Mr. MEYER. We will try to lay out some of the various ways in which consumers could benefit and get back to you with that.

    Ms. WATERS. Thank you.

    Thank you very much, Mr. Chairman.

    Chairman LEACH. My eyes have grown weary as Chairman of this committee. I am just wondering, Ms. Waters, is that Mr. Metcalf sitting next to you?
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    Ms. WATERS. Yes, it is. We have teamed up on this one.

    Chairman LEACH. Mr. Lazio.

    Mr. LAZIO. Thank you, Mr. Chairman. I want to welcome the two witnesses. I will not ask questions particularly on topic, but I just want to make one comment with the secretary here, and it is good to see you again. I want to thank you for your help on financial modernization.

    Mr. GENSLER. It is good to see you, Congressman.

    Mr. LAZIO. I just want to make note of the fact with the controversies involving the GSEs, how important it is to me, and I know to many Members of Congress, that we give a very thoughtful approach and do not get involved in anything that undermines what is the most efficient secondary market in the world, provides liquidity for the industry and brings the promise of home ownership to a lot of folks that would otherwise not be able to have that prospect. Anything that undermines that by having the net effect of raising costs to homeowners, I hope that you will stay clear of, the Administration will stay clear of, and I do believe that most of us in Congress will stay clear of.

    Thank you.

    Chairman LEACH. Thank you, Rick.

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    Mrs. Maloney, do you have a question?

    Mrs. MALONEY. Thank you. It is a delight to see both of you.

    Do you know how much money would be involved generally? Do you have any idea if this would happen?

    Mr. GENSLER. The estimates of the Congressional Budget Office and Office of Management and Budget estimate that the interest on reserves net of the taxes that the Treasury would then take in, net of a couple of other technical factors, would, over five years, be about $600 million, starting around $160 million and then declining to about $100 million in the third year and thereout. So, about $100 million by the third year would go from the taxpayers to the banking industry. And as Congresswoman Waters asked, maybe some of that would go on from the banking industry to others.

    Mrs. MALONEY. What would be the impact on other programs, such as housing, that this committee oversees if this happened, the paying of the interest on the sterile reserves? What would be the impact?

    Mr. GENSLER. The issue raised is the setting of the priorities and how Congress would grapple with how to fund this $600 million over five years, which is highlighted in Treasury testimony.

    Mrs. MALONEY. In other words, $600 million would be taken out of other programs?
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    Mr. GENSLER. That is, in a sense, for the Administration, the one issue as to why at this time we are unable to support the legislation—how to pay for it and how to set priorities.

    Mrs. MALONEY. Thank you very much. I have a statement that I would like put in the record, Mr. Chairman, if I could.

    Chairman LEACH. Without objection.

    The Chair would certainly respond to one aspect of your question, that is, there is no intention whatsoever that a dime come out of housing programs to meet this particular obligation.

    Mr. Watt, do you have any questions?

    Mr. WATT. Mr. Chairman, if I could pass.

    Chairman LEACH. Yes, of course. Ms. Schakowsky, would you care to be recognized?


    Chairman LEACH. Let me thank both of our distinguished witnesses. Let me repeat again my appreciation for the thoughtfulness of the testimony. I am particularly appreciative that, in the past, some implicit regulatory arbitrage issues have come up in the context of this issue. I am pleased that they do not appear to be on the table at this time. I want to thank both witnesses for both a lengthy and subtle analysis of the issue as well as a very thoughtful discussion of some of its implications. Thank you.
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    Ms. WATERS. Mr. Chairman, I would like unanimous consent to submit my statement for the record.

    Chairman LEACH. Without objection.

    Mr. GENSLER. Thank you, Mr. Chairman, and all the Members of the committee.

    Mr. MEYER. Thank you.

    Chairman LEACH. Our next panel is composed of Mr. Carl Tannenbaum, the Senior Vice President and Chief Economist for Treasury Research, Lasalle Banks, Chicago, Illinois, on behalf of the American Bankers Association; Mr. A. Pierce Stone, President and CEO of Virginia Community Bank, Louisa, Virginia on behalf of the Independent Community Bankers of America; Mr. Manuel Mehos, Chairman, President and CEO, Coastal Banc, Houston, Texas, on behalf of America's Community Bankers; and Mr. Thomas P. Jennings, Senior Vice President and General Counsel, First Virginia Banks, Inc. on behalf of the Financial Services Roundtable.

    I welcome all of you, and let me say, without objection, all of your full statements will be placed in the record. You may proceed as you see fit. We will begin with you, Mr. Tannenbaum.

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    Mr. TANNENBAUM. Thank you, Mr. Chairman. I would like to thank you for holding this hearing on the payment of interest on reserves held at Federal Reserve banks. We also want to thank representatives Kelly, Maloney and Metcalf for introducing H.R. 4209, because the ABA strongly supports this bill.

    I would like to make several points this morning. First, paying interest on reserves will facilitate the development of transaction deposit products and level the playing field between banks and other financial institutions. Second, required reserves held at the Federal Reserve banks will continue to decline unless market interest rates are paid on these funds. Third, paying interest on reserves could help the Federal Reserve conduct monetary policy. And, fourth, interest on reserves would, in fact, represent an improvement for the Federal budget in the long run.

    The lack of interest on sterile reserves imposes a heavy burden on bank deposits. The direct cost to banks is the forgone interest on lending reserve funds back into our local communities. Conservatively, we estimate this cost at $400 million this year. However, the cost to our communities are many multiples of this due to the additional forgone lending opportunities that would certainly arise. The cost of sterile reserves create an incentive for banks to minimize this burden. To do this, banks use sweep accounts, which automatically transfer customer balances off the bank's books and into money market instruments or funds that provide our customers market rates of interest and are not burdened by reserve requirements.

    As a consequence, since late 1993, reserve balances at the Federal Reserve banks have dropped from almost $30 billion to $6.5 billion as of last March. Some will argue that the decline of reserves will level off because of compensating balances held by commercial borrowers and balances held for clearing checks. But I can tell you that compensating balances are becoming increasingly rare, and banks have other alternatives than clearing checks through the Federal Reserve system.
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    H.R. 4209 would authorize the Fed to pay interest on reserves. I want to emphasize, though, that unless market rates of interest are paid, we can expect reserve balances to continue their decline. Anything short of a market interest rate perpetuates the opportunity cost faced by banks and perpetuates existing reserve avoidance mechanisms.

    ABA believes that H.R. 4209 has several important advantages. First, paying interest on reserves would facilitate the development of new deposit products, transaction deposit products for our customers by freeing the costs and technological resources that are currently devoted to the maintenance of sweep structures. Second, paying interest on reserves would help level the playing field within the financial services industry. Non-banks offer very similar products to bank deposits, yet are not subject to the same reserve requirements.

    As well, international institutions also have an advantage here as has been mentioned since foreign central banks routinely pay interest on their reserve balances. Third, paying interest would allow the Federal Reserve, as has been mentioned, to maintain reserves at whatever level they deem appropriate to conduct monetary policy. This could be achieved by varying the level of the rate to such a level that balances held within the system are optimal for the conduct of monetary policy.

    Finally, let me address the budget issue that surrounds this bill. Some argue that paying interest would have a negative budget impact, but I can tell you that without the payment of interest, reserves will eventually vanish and so will the Federal revenues received from this source. However, if interest is paid, the decline in reserves will be stemmed and Federal revenues will increase from what they would have been. Simply put, the payment of interest will yield a budgetary gain over time. In conclusion, Mr. Chairman, we support H.R. 4209. Paying of interest on reserve balances at the Federal Reserve, as authorized in this bill, could reverse the decline in those reserves, would maintain reserves at a level necessary for the conduct of monetary policy, and would make banks more competitive. Thank you.
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    Chairman LEACH. Thank you very much, Mr. Tannenbaum.

    Our next witness is Mr. Stone. Please proceed.


    Mr. STONE. Thank you, Mr. Chairman, Ranking Member LaFalce, Members of the committee. My name is Pierce Stone, I am Chairman, President and CEO of Virginia Community Bank in Louisa, Virginia. I also serve as Vice President of the Independent Community Bankers of America, on whose behalf I appear before you today. I appreciate this opportunity to testify on H.R. 4209, the Bank Reserves Modernization Act of 2000. As you noted in your letter, Mr. Chairman, in your letter of invitation, the reserve balances held by depository institutions at Federal Reserve banks have dropped sharply.

    One reason for that is that many institutions reduce the amount in their transaction accounts by sweeping funds into non-reservable instruments at the end of each day. This procedure, while fairly common among the larger banks, is not typically used by smaller institutions, such as mine, most of which can meet their reserve requirements by maintaining sufficient levels of vault cash. Vault cash, like sterile reserves maintained at the Fed, is idle and does not earn interest. Unlike reserves held at the Fed, however, these cash reserves would not earn interest under the Kelly bill.

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    Another reason for the decline is that over the last ten years, there has been a proliferation of deposit options available to bank customers. Customers are placing more of their funds in IRAs and 401Ks, buying mutual funds, bonds and certificates of deposit, and as the internet becomes the portal of choice for people to gain access to financial services, there has been a growth in equity and cash management accounts.

    These market options were not as prevalent ten years ago. Some of these options have also made it more difficult for some community banks to attract and maintain core deposits, which is why the ICBA has called for an increase in deposit insurance to $200,000. $200,000 would just about cover inflation erosion since 1980 when it was last adjusted. We are also calling for 100 percent coverage of municipal deposits which would benefit local communities as well as all community financial institutions.

    As you know, with the passage of Gramm-Leach-Bliley, there will be a growing number of too-big-to-fail institutions whose uninsured depositors have de facto 100 percent coverage. Regulators have acted to ensure that institutions presenting systemic risk to our financial system will not be allowed to fail, but I will leave the issue of deposit insurance for a hearing on another day, perhaps, maybe not too far away.

    Anyway, certainly, Mr. Chairman, we share your concern that the decline in reserves could affect the Federal Reserve's ability to execute monetary policy and lead to uncertainties in overnight interest rates. Chairman Greenspan has made this argument in congressional testimony, and we are certainly inclined to listen carefully when the Chairman speaks.

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    The purpose of H.R. 4209 is to require the Fed to pay interest on these reserves. Clearly, the largest depository institutions would be the biggest beneficiaries of this proposal. This was confirmed by the Fed, who told us in a letter that if interest were paid on required reserve balances, the dollar payments would be heavily skewed to banks ranking in the top fifth by deposits. For example, if a bank had $50 billion in transaction accounts, that bank's reserve requirement would be nearly $5 billion. At a simple interest rate of 5 percent, the interest on that $5 billion reserve balance would be $250 million a year.

    That, Mr. Chairman, is not small change. By contrast, my $120 million bank has $104 million in deposits with $32 million in reservable transaction accounts. My reserve requirement of $960,000 is fully satisfied by vault cash. So under the terms of H.R. 4209, I would not stand to earn a penny in interest. The same would be true for most ICBA members. The average ICBA member has $25 million in transaction deposits. Most banks of this size are able to meet their reserve requirements using vault cash. They would not have to maintain reserves at a Federal Reserve bank.

    Could the payment of interest on reserves lead to more small banks establishing reserve accounts at the Fed? Perhaps, but that would be very difficult to calculate.

    The cash maintained at community banks is there not only to meet their reserve requirements, but also to meet the cash needs of their customers. So we should not assume that the opportunity to earn interest would necessarily lead to moving significant amounts of cash from vaults to the Federal Reserve banks. If the committee elects to proceed with this legislation, we would urge the committee to consider the fairness of the legislation and look at options that would benefit community banks as well.
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    I mentioned the concept of equivalency payments in my written testimony. This would treat the vault cash reserves the same as reserves maintained at the Fed for purposes of calculating interest payments, ensuring fair treatment for those who maintain reserves at the Fed, and for those who satisfy their requirements with vault cash. I don't know whether this would work or not, but it is certainly worth looking into.

    In conclusion, Mr. Chairman, the legislation under discussion would benefit the Nation's largest depository institutions while providing little, if any, benefits for most community banks. We ask you to consider the fairness of this outcome, and we hope the committee will consider options that would benefit community banks as well. We stand ready to work with you and other committee Members to make this legislation more equitable to our Nation's community bankers.

    Thank you for the opportunity to testify. I will be glad to answer any questions any committee Members may have.

    Chairman LEACH. Thank you, Mr. Stone.

    At this point I would like to turn to Mr. Bentsen, please.

    Mr. BENTSEN. I thank the Chairman.

    Mr. Chairman, I just want to take the opportunity to welcome a constituent, Manuel J. Mehos, who is going to testify, who is the Chairman and CEO of Coastal State Savings Bank, a State-chartered savings bank in Houston, Texas. Mr. Chairman, I would just add that even though from time to time we have had differences of opinion with respect to thrifts, Mr. Mehos' thrift is one of the good stories about the thrifts in coming out of the ashes of the 1980's and rebuilding a thrift into what has become quite a financial powerhouse in the greater Houston, Texas market.
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    Thank you, Mr. Chairman.

    Chairman LEACH. Thank you. With Mr. Mehos's returning to this committee to testify, we welcome you. The Chair certainly shares the perspective of Mr. Bentsen. Please proceed.


    Mr. MEHOS. Thank you, Mr. Chairman, thank you, Congressman Bentsen for those kind words. I hope we can live up to them. As Congressman Bentsen said, my name is Manuel Mehos. I am Chairman, president and CEO of Coastal Banc in Houston, a State-chartered Texas State savings bank. I welcome the opportunity to present America's Community Bankers' views on H.R. 4209, the Bank Reserves Modernization Act. Before discussing this bill, I would like to commend Chairman Leach and the banking committee for successfully moving H.R. 4067, the Business Checking Modernization Act, through the House.

    By allowing banks the ability to offer their customers interest-bearing checking accounts, H.R. 4067 will increase opportunities for small businesses to obtain these products and help community banks attract and maintain deposit funding that is essential for lending activities. We hope that the Senate will soon follow the House's lead and pass companion legislation that can be enacted this year.

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    ACB strongly supports H.R. 4209, introduced by Representative Sue Kelly, which would authorize the Federal Reserve to pay interest on reserves held by depository institutions at the Federal Reserve banks. This reserve is the equivalent of a tax in the form of a non-interest-bearing loan to the Government. Authorizing the payment on reserves will eliminate this tax, create much greater efficiencies in the banking system by allowing banks to earn a return on all of their assets, and result in deposits being more fully invested into communities.

    Moreover, competitive market forces will result in most of the earnings that banks receive on reserves being passed along to bank customers through reduced costs for services and higher interest rate returns on deposit accounts.

    I would like to address the concerns raised about the possible loss of revenue from this proposed change in law. While passage of H.R. 4209 would result in a short-term reduction in the Federal Reserve's surplus as interest payments on reserves are made, we believe that the loss of revenue would not be large over the long run. Indeed, I agree with Governor Meyer that if this legislation is not enacted, Federal reserves will continue to decline, which costs the Government lost income.

    I believe Governor Meyer said that he expects it to be down to $4 billion by the end of next year if this legislation is not passed. Passage of the bill will allow banks to compete more effectively with non-depositories, which are not subject to reserve requirements, but offer depositlike instruments. ACB believes that the costs of paying interest on reserves by the Federal Reserve could, over time, be substantially offset by higher reserve levels at Federal Reserve banks. These higher reserve levels, which would, in turn, earn a higher portfolio yield than the interest payments made by the Fed to us the banks on these reserves, could generate enough income to offset the incremental cost of interest payments on reserves.
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    Stated more simply, the Fed will earn more spread that would cover the increased costs. ACB urges the Banking Committee to mark up and approve H.R. 4209. Passage of this bill will help foster greater market efficiencies and competitive equity in the financial services industry.

    Interest on reserves will also help counter the escalating growth of sweep arrangements and the resulting reduction in the required reserves held at Federal Reserve banks. This will facilitate the conduct of monetary policy at a time when the Federal Reserve is engaged in a very delicate exercise of restraining overall demand and inflationary pressures to prolong the economic expansion and benign economic climate from which we all, banks included, have benefited so much.

    Again, Mr. Chairman, and Members of the committee, thank you for the opportunity to express our views on this important legislation. I, of course, will be happy to answer any questions.

    Thank you.

    Chairman LEACH. Thank you, Mr. Mehos.

    Our final witness, representing the Financial Services Roundtable, is Mr. Thomas Jennings.

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    Mr. JENNINGS. Thank you, Mr. Chairman. My name is Thomas P. Jennings, and I am General Counsel of First Virginia Banks, Inc. in Falls Church, Virginia. I am pleased to have the opportunity to speak today on behalf of the Financial Services Roundtable. First Virginia is the oldest bank holding company in Virginia with roots beginning in 1949. We are now a multi-State organization with banking companies in Virginia, Maryland and Tennessee, and non-banking offices throughout the mid-Atlantic and southeastern States.

    The Financial Services Roundtable is a national association whose membership is reserved for 100 companies selected from the Nation's 150 largest integrated financial services firms.

    Chairman Leach, thank you for holding the hearing today and for inviting the Roundtable to participate. The Roundtable also extends thanks to Congresswoman Sue Kelly for introducing H.R. 4209, the Bank Reserves Modernization Act of 2000, which will be the focus of my testimony.

    Further, the Roundtable thanks the original co-sponsors, Congressmen Jack Metcalf and Jim Maloney, and also thanks Congressman Charlie Gonzalez, who announced his support for this legislation last night. This bill would help remove the hidden tax imposed on banks by allowing the payment of interest on banks required reserves.

    On March 29 of this year, the committee marked up legislation to allow banks and thrifts to pay interest on commercial checking accounts. The Roundtable strongly believes that before a final bill is sent to the President, the Congress should couple the provisions of this legislation with a bill to allow interest on commercial checking accounts. The reason for this is simple. Banks will be forced to undertake significant changes in operating systems, and more importantly, they will be pressured also to revisit their pricing for numerous account relationships if interest on commercial checking becomes law.
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    As explained by Federal Reserve Governor Laurence Meyer in testimony given last year to the Financial Institutions Subcommittee, ''For banks, interest on demand deposits will increase costs. These costs will be partially offset by interest on reserve balances.'' Sterile reserves held at the Federal Reserve amount to a hidden tax on banks. This non-productive use of deposits runs counter to the interest of all our key constituencies, including our bank's management, shareholders, and most importantly, our customers and our communities.

    Let me explain how the bill to permit the payment of interest on business checking will affect First Virginia. Currently, our family of banks meets virtually all of its reserve requirements through vault cash, that is, the money we keep in our branches and other facilities and through required clearing balances held at the Federal Reserve.

    First Virginia has a program in place to aggressively manage the cash we hold, and where we hold it in order to ensure that our customers receive cash when they need it. Because banks our size must hold 10 cents in reserves for every additional dollar held in checking accounts, allowing the payment of interest on business checking accounts could substantially increase our reserve requirements. The corresponding increase in required reserves may force us to hold excess cash over and above the amount that we need to meet our customers' needs.

    Carrying this money without receiving interest on it or without being able to put it to productive use could increase the hidden tax paid by our institutions. If the Federal Reserve banks were to pay First Virginia and other banks interest on the reserves kept with them, the cost of holding these excess reserves would be partially offset.

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    I also would like to point out a potential unintended consequence if a policy change results in banks holding additional non-interest bearing reserves. Because an increase in such reserves would make it more expensive for banks to offer checking accounts, many consumers might choose to place their money in accounts outside the banking system. The end result might be that even fewer reserves would be held by the Federal Reserve, because fewer deposits would be held by banks.

    In the past, Congress has always linked the issue of paying interest on required reserves to paying interest on commercial checking. In 1998, this committee introduced provisions as part of a broader regulatory relief package. That bill, H.R. 4364, passed the House by voice vote. As the committee has already heard, strong monetary policy arguments exist for allowing the Federal Reserve to pay interest on required reserves.

    While I will not go into the details of the monetary policy-related issues, I will point out that Federal Reserve officials—and we have heard that again today—have frequently supported positive congressional action in this area.

    Mr. Chairman, in conclusion, the Roundtable appreciates the opportunity to provide our comments on this important legislation that will remove the hidden tax on banks and urges Congress to follow its historical practice of combining payment of interest on reserves legislation with interest on commercial checking legislation.

    Thank you again for this opportunity, and I will be pleased to answer any questions that the committee might have on this issue.

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    Chairman LEACH. Thank you, Mr. Jennings.

    Mr. Lazio.

    Mr. LAZIO. No questions.

    Chairman LEACH. Mrs. Kelly.

    Mrs. KELLY. Thank you, Mr. Chairman. I do have a couple of questions.

    Mr. Mehos, you cite Federal Reserve surveys indicate that about two-thirds of banks would unwind sweep arrangements and offer more competitive deposit accounts if interest was paid on reserves. The survey also states that a number of banks might develop new types of accounts designed to bring customers back into the bank and away from the non-depository institutions. It would seem that such events would clearly be pro consumer. Do you have any additional comments you would like to offer on how the typical consumer might benefit from this legislation?

    Mr. MEHOS. Yes, Congresswoman Kelly. It is our opinion that most of the benefit from this legislation, in fact, most of the benefit will be attributed to the consumer and will flow through to the consumer. I won't go into too much technology of how we measure our return, but banks usually have a certain return on equity target that they try to reach. Those targets remain generally the same.

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    As long as they can reach those targets, they will set pricing, they will set products, they will set thresholds in order to reach that target, not necessarily to increase the target. If this legislation is passed and we are allowed to be paid interest on the reserves and in turn, that is a lower cost to us, we can not only create accounts that have tiered thresholds. In other words, demand deposit accounts, you might have a checking account or a money market account like this whereby it has certain tiers; the more money you have in it, the higher interest rate you earn and it has different levels of tiers.

    For example, we can drop those tiers to lower levels, where it requires less money for you to earn a higher rate of interest. We will be able to do this because our reserves are earning interest. That is a good example of how it passes through. Because of competitive forces, I don't believe that the banks will end up absorbing bottom line much of this benefit. Most of it will actually reach the consumer.

    Mrs. KELLY. Thank you very much.

    Mr. Tannenbaum, one potential result of the dwindling reserve balances is a volatile Fed fund rate. How would volatility in the short term rate affect a bank's operations?

    Mr. TANNENBAUM. Are you asking me?

    Mrs. KELLY. I am sorry, I am. How would volatility in the short term rate affect a bank's operations?

    Mr. TANNENBAUM. Volatility is the enemy of any kind of effort at stabilizing what is happening in the economy. And as I think Governor Meyer expressed, when the level of reserves gets very low, it will be very difficult to hit a target that they feel is consistent with the economic goals that they have. I can assure you that there may not be a floor on how low reserves will go in the absence of this legislation. Sweep products are becoming available to ever smaller institutions. The technology is becoming more inexpensive, firms have a lot of incentive to put those in place for institutions that will benefit from them.
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    One of the impacts of e-commerce is that markets become more efficient, money moves more rapidly. Money that institutions have to keep for clearing balances also can be expected to decline substantially. As Governor Meyer pointed out, while this may not be an issue now, as reserves continue to dwindle and as we feel that they will, their ability to set a monetary policy that continues to develop the sort of expansion that all of us have been very pleased with will be jeopardized.

    Mrs. KELLY. Thank you, Mr. Tannenbaum.

    Mr. Stone, there is some testimony on page 3 of yours that raises a question in my mind. You say that many smaller institutions can meet their reserve requirements by maintaining sufficient levels of vault cash, or a combination of vault cash and reserve accounts. Then you say unlike reserves held at the Federal Reserve banks, interest would not be paid on these cash reserves under the Kelly bill. Well, interest isn't currently paid on them now; is that correct?

    Mr. STONE. That is correct.

    Mrs. KELLY. How would this change? And are you implying with this statement that you expect the Fed to provide interest on vault cash?

    Mr. STONE. It would be very nice, but I don't know that that is the real world.

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    Mrs. KELLY. I just wanted you to clarify that.

    Mr. STONE. As community banks, we will get nothing out of this bill from an income standpoint. However, in general we are very supportive of the Federal Reserve and the wonderful job it has done in monetary policy, and I think that we probably have to look at the overall monetary policies as the most important issue that we are dealing with here. And I think the Chairman has referred to that earlier, that that is very important.

    I do think that paying interest on these reserves, even though we haven't seen a way that it is going to help the community banks, it is going to bring money back into the community in conjunction with the other bill, I don't remember the name of it, the one that has already been passed by the House on paying interest on business accounts. I think that is an important bill. Let me say, I don't speak for every community banker in the country, they don't all agree with that, but I would think the majority certainly does.

    Mrs. KELLY. If the budgetary issue is resolved, would you support the bill?

    Mr. STONE. I believe very strongly in the job that Mr. Greenspan has done for the country for many, many years. He is a wonderful economist. So I could not not support the bill. But I would like for it—honestly, I would like for something to be in it for my community bankers and for my little $120 million bank in Virginia.

    Mrs. KELLY. I think that is understandable, but I think what may be in this bill for you is a better monetary policy, as you pointed out. I thank you, Mr. Chairman.
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    Mr. STONE. I don't disagree with you.

    Mrs. KELLY. Thank you very much.

    Chairman LEACH. Thank you, Mrs. Kelly.

    Mr. Watt.

    Mr. WATT. Thank you, Mr. Chairman. I want to thank the Chairman for conducting this hearing today and apologize to him for not being here earlier to participate in the first panel and making the comments that I am going to make now, which really probably would have been more appropriate.

    First of all, I want to thank Mrs. Kelly for offering this bill. I am not currently a co-sponsor of the bill, but the primary reason is because we have a pretty extensive review policy in our office and we are in the process of looking at it very closely.

    I do want to talk about this, though, in the context of a very strong bias that you all have heard me express several times in this committee, and that is the payment, not to have sterile funds just sitting around doing nothing and not drawing interest, and assuming that that is not costing anybody anything. I think this bill really needs to be viewed in the context of that backdrop as being consistent with what several of the people who have testified today have said, as being consistent with H.R. 4067, where we are encouraging the payment of interest on checking accounts, because that money really belongs to somebody, and to the extent that it is sitting in a checking account and doesn't draw any interest is costing somebody something.
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    It has to be viewed in the context of Mr. Lucas and my bill, H.R. 4082, which would put excess deposit insurance funds to work, because when we don't do that, somebody is paying for that and somebody is losing interest on that. It has to be viewed in the context of a suggestion that I have made, and am currently studying and probably will be dropping a bill that I hope other Members on the committee will favorably consider that would require payment of interest on escrow deposits related to mortgages for taxes and insurance, which I think is a source of funds that is just kind of sitting there in most banks, and people are not really drawing interest on it.

    I think somebody is benefiting from it, I just don't think the right people are benefiting from it. I would support Mr. Stone's concept to treat these transaction deposit moneys as part of the reserve so that they could be drawing interest. There is no reason that just because the money is in your vault, as long as it is there safe and secure, it couldn't be considered as part of a reserve also and be drawing interest.

    So I think we have to look at this as an effort and I applaud the Chairman's openmindedness about bringing these concepts to the committee that pays interest and uses funds and encourages the use of funds that are just sitting around doing nothing. They clearly are benefiting somebody. I just think that the beneficiaries of these funds sitting around is not always the appropriate beneficiary. I think somebody is drawing interest on these reserves that are sitting at the Fed.

    The banks ought to be drawing the interest. Somebody is drawing interest on the checking account deposits. But the consumers, the depositors ought to be drawing that interest rather than the banks. Somebody is benefiting from these excess deposits for insurance purposes. The banks ought to be benefiting from that, not the Federal Government, so that we can balance our budget. All of this—and, of course, my pet peeve, somebody ought to be benefiting other than the mortgage companies from interest that is being drawn on mortgage escrow deposits for insurance and taxes, that the people who are putting those moneys into those accounts ought to be benefiting from it.
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    So I guess if I have a bias, it is a strong bias in favor of people who really are the owners of these funds getting the benefit of whatever interest is drawn on them. Sometimes that will cut for the banks, sometimes it will cut against the banks. It will cut in different ways, but ultimately, all the times it seems to me, the ultimate beneficiary is the consumer and the customer, because as Mr. Mehos indicated, all of us have targets, the banks have targets about profit margins, and if they can get their targets met, then they can pass that extra profit along to consumers. That is the ultimate beneficiary that we always ought to be looking at.

    I hope I didn't get on a soapbox. I appreciate the time. I appreciate the Chairman having the hearing. I don't have a question, obviously, because I am out of time.

    Chairman LEACH. Well, if it was a soapbox, it was a very thoughtful one. Let me say, we have a vote to be followed by a series of votes. Everyone is entitled to five minutes, but if we can hold it to two or three minutes, we might be able to wrap up the hearing. At this point, let me recognize Mrs. Biggert.

    Mrs. BIGGERT. Thank you, Mr. Chairman. First of all, I would like to thank you for holding the hearing and take this opportunity to welcome one of my constituents here, Mr. Tannenbaum, who is with the Lasalle Bank and the ABA and has always come to the district for what we call the East-West Corridor Association, and given us an economic forecast for the year. When he is there, everybody listens and we have the highest attendance.

    Mr. TANNENBAUM. It is never right, but people listen. Thank you.
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    Mrs. BIGGERT. I would like to commend you and your staff for having, for the last two hearings, one of my constituents here. Thank you.

    First of all, I would like to ask Mr. Tannenbaum, the Federal Reserve's statement or testimony states that if a bill becomes law, the Fed would likely pay an interest rate on required reserve balances close to the rate on other risk-free money market instruments such as repurchase agreements. Does that mean that that is the rate that you are talking about, that you are so concerned that it is the market interest rate?

    Mr. TANNENBAUM. Yes, I think that would be in the range of the rates that would be necessary to achieve the benefits that we see in this bill to give banks incentive to begin dismantling the sweep structures that are avoiding the implicit tax to begin reallocating the technological and human resources that are at work currently on sweep products to come up with new types of tiers, as was mentioned before, or a structure which would allow consumers of financial services to see all of their accounts on one statement, obviously which would require some technological programming that might be made available. Certainly that would be in the range to get us started on achieving those benefits.

    Ms. BIGGERT. Is there any way that we can assure the taxpayer or the consumer that they would reap any benefit from the banks receiving the interest in these reserves?

    Mr. TANNENBAUM. Well, I think that would be an inevitable outcome. What we have to realize is that currently 10 cents of every dollar that we have in commercial checking accounts is money that we cannot put to work in our local communities. As I have stressed already, the resources that we are currently spending to minimize the burdens of reserve requirements would also be resources that could be reallocated.
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    I would add that the benefit to small banks, even those that meet their reserve requirements through vault cash, would be that economic performance would be improved. Maybe some of Mr. Stone's constituents would be the recipients of business loans that might not have been forwarded before; overall economic growth would accrue to his institution in the form of a larger deposit base, perhaps more business opportunities. So all of that would certainly be a result of the bill.

    Ms. BIGGERT. And then if there were to be a draft or a compromise between your sentiments and the Treasury by paying an interest rate less than the market rate, would lending institutions still be in favor of this proposal?

    Mr. TANNENBAUM. Well, absent details on exactly at what level that would be set, it would be difficult for me to anticipate an outcome. We would all have to go through the exercise of determining what monies are being spent on reserve avoidance at the moment and how it would benefit our customers, and come up with a decision on how we would react in the form of our reserve balances. I can assure you, however, at the margin that this would start along a process that, as we have outlined, would be very positive not just for monetary policy, but also again we feel in the long run it would help stem the erosion of the interest that is currently being returned by the Fed to the Treasury.

    Ms. BIGGERT. Thank you.

    Because of the time, I will end my questioning. Thank you, Mr. Chairman.

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    Chairman LEACH. Thank you, Mrs. Biggert.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman. I have just a couple of quick questions, first of all, I guess to—well, to the entire panel.

    Mr. Stone, you raised the concern that the bigger banks are going to benefit from this, the bigger institutions, and the smaller institutions will not and therefore there is an inequity. But isn't there—I mean, for the smaller institutions you conduct—I don't know about your bank in particular, but the smaller institutions tend to conduct a lot of business with the larger institutions in access to funds and parceling out loans, and so forth.

    Do you believe that if paying this interest to the larger institutions inures to their pricing, that that will benefit your pricing structure and your relationships with those larger institutions? Don't you think ultimately some of that will pass through to the community banks that have transactional relationships with the larger banks?

    Mr. STONE. You know, curiously you talked about us participating in loans, but in my particular bank in Virginia, I actually have a lot more luck in participating in loans with my fellow bankers rather than the large banks. You know, that is just one point.

    Mr. BENTSEN. Right. Right.

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    Mr. STONE. And actually I have been thinking about how that might affect me, and I compete against the largest banks in the country in my market in Virginia. If they are getting this income and I am not getting it, they would be allowed to lower the rates that they charge on loans and raise the interest rates that they pay on savings. So it would probably squeeze my margin a little tighter than they are right now.

    Mr. BENTSEN. I may not completely understand this.

    Mr. STONE. I can't hear you, sir.

    Mr. BENTSEN. If your needs are such that you only have to have vault cash available because of the size of your institution, compared to the other, isn't the larger institution at somewhat—at least just on paper—at a mathematical disadvantage, because they have a large amount of sterile reserves, that they are larger proportionately than you do, that are not earning interest?

    Mr. STONE. Yes, I would have to agree with you.

    Mr. BENTSEN. So, in an apples-to-apples comparison, even if one apple is 10 times larger than the other, I think you have to look at that end of the balance as well.

    And would it not be true also that the larger institution would still be required to have their vault cash as well, and so in that respect would they be on par from the standpoint of cash that is sterile—obviously, not dollar par, but in a proportional sense?
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    Mr. STONE. They would still have to keep their reserve cash as well.

    Mr. BENTSEN. I am not convinced that paying interest on vault cash is the same as paying interest on sterile reserves, and I will have to look at that more closely.

    I think there is a little bit different function for vault cash. So if you were to pay interest on vault cash, then you would be back to the—I mean, they could argue you are back to the inequity that they enjoy or do not enjoy at this point in time.

    Mr. STONE. Yes.

    Mr. BENTSEN. Thank you, Mr. Chairman.

    Chairman LEACH. Mrs. Schakowsky.

    Mrs. SCHAKOWSKY. Thank you, gentlemen. I am afraid I find irresistible my need to step on a soapbox for a moment.

    Chairman LEACH. If the gentlelady would yield, if you want to go for more than 30 seconds.

    Mrs. SCHAKOWSKY. About 30 seconds.
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    I hope it is true that most of the benefits will be passed on to consumers; or, Mr. Tannenbaum, as you say, the inevitable consequence is, the consumers will benefit.

    But I would just like to point out that in the last three years we have seen a 640 percent increase in ATM fees. In the last five years we have seen a doubling of the fees for returned checks, so they average about $25 to $29 now for people who bounce a check; $25 to $29 on late fees on credit cards, which many of the large banks issue; very few banks that offer lifeline banking services now with the passage of the Financial Modernization Act; a lack of privacy.

    I am really anxious for the day when we see before us legislation, serious legislation that will really give benefits to consumers. I have introduced a financial consumer's bill of rights in the last two weeks that would address a lot of these issues.

    I am sorry, but I am not taking out my crying rag right now for the banks that are doing very well right now and would like to see not perhaps passing onto consumers, but some actual passing onto consumers. In fact, we are going the other way.

    I haven't made up my mind on this piece of legislation, but I wanted to say this on behalf of ordinary consumers whose concerns have not really been addressed to my satisfaction. Thank you.

    Chairman LEACH. Thank you. Thank you for being so concise in your thoughts.
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    Let me just conclude by saying that one of the awkward aspects of this whole issue is that the economy has a vested interest in monetary policy working, particularly the banking industry has a vested interest, and yet we build in perverse incentives for the banking industry to undercut monetary policy with the current refusal to give interest on reserves. And, therefore, it is my own view that this is common-sense reform that is particularly timely, partly because it simply is less costly than was the case a decade or seven years ago and partly because if we don't move in this direction, monetary policy could become far more disrupted than it is today. And this is the time to act and it is a very credible thing to do.

    Let me thank the panel. Let me apologize. We are on the rush to a series of votes, but let me thank you all very much.

    [Whereupon, at 12:10 p.m., the hearing was adjourned.]