A recent paper by Morgan Ricks, John Crawford, and Lev Menand argued that the public should be allowed to have a bank account at the Fed:
Among the perks of being a bank is the privilege of holding an account with the central bank. Unavailable to individuals and nonbank businesses, central bank accounts pay higher interest than ordinary bank accounts. Payments between these accounts clear instantly; banks needn’t wait days or even minutes for incoming payments to post. On top of that, central bank accounts are pure money—economically equivalent to dollar bills—meaning they are fully sovereign and nondefaultable no matter how large the balance. By contrast, federal deposit insurance for ordinary bank accounts maxes out at $250,000—a big problem for institutions with large balances.
The time has come to end this special privilege of banks. We propose giving the general public—individuals, businesses, and institutions—the option to have a bank account at the Federal Reserve. We call it a FedAccount. FedAccounts would offer all the functionality of ordinary bank accounts with the exception of overdraft coverage. They would also have all the special features that banks currently enjoy on their central bank accounts—including unlimited secure balances, instant in-network payments, and a higher interest rate—as well as some additional, complementary features.
This sort of proposal has both pros and cons. In my view, the biggest “pro” is that it would allow for the abolition of deposit insurance, which I regard as one of the most underrated flaws in our financial system. I emphasize “would allow” rather than “would lead to” because I fear that it would not in fact lead to the abolition of deposit insurance. Special interest groups would probably prevent that outcome. Indeed we might end up with both access to the Fed balance sheet and FDIC, not my preferred regime.
On balance, my preference would be to go back to the pre-2008 regime, where there was no interest paid on bank reserves and the Fed balance sheet was much smaller. But I would support a deal that combined public access to interest earning Fed accounts with abolition of FDIC. (BTW, unlike most other economists, I see “too big to fail” as a far smaller problem than FDIC.)
Even if the Fed does not allow private accounts, it ought to be possible for a financial institution to provide a similar service. And according to the WSJ, the private sector has indeed spotted this market niche:
TNB USA Inc.—run by a former top New York Fed staffer—said its primary business activity will be to enable large institutional money-market investors to earn higher interest rates from the Federal Reserve than they could otherwise, according a complaint filed in federal court Friday. Such investors include pension funds, companies and other entities managing large sums of money.
But first TNB, based in Connecticut, needs to open an interest-bearing account at the New York Fed, like those held by many large banks. . . .
[I]ts “sole business will be to accept deposits from the most financially secure institutions” and place that money in an interest-bearing Fed account, “permitting depositors to earn higher rates of interest than are currently available to nonfinancial companies and consumers,” the filing said.
TNB’s customers will primarily be institutional money-market investors, but it would also accept deposits from foreign central banks, the filing said.
Although this proposed “narrow bank” would primarily serve large institutions, the broader public would benefit from higher returns on money invested with pension funds, etc. So what does the Fed think of this proposal?
The Fed hasn’t granted or rejected TNB’s request, a process begun in August 2017, or provided a formal reason for not acting. TNB alleges in its court filing that New York Fed officials were prepared to open the account, but the Fed’s Washington-based board of governors blocked it because of unspecified “policy concerns.”
The plaintiffs said in the lawsuit they attributed the decision to the board chairman, Jerome Powell, based on their conversations with New York Fed officials.
TNB is asking the U.S. District Court for the Southern District of New York to order the New York Fed to open the account. The suit cites a 1980 law saying such accounts shall be available to any qualified depository institution that receives deposits other than trust funds.
My first reaction is, “that doesn’t look good”. My second reaction is, “I really don’t know enough about this to criticize the Fed’s decision”. And my third and final reaction is back to “that doesn’t look good”, because the Fed’s “policy concerns” are unspecified. I can imagine how there might be policy concerns that I’m not aware of. What I can’t imagine is why these policy concerns need to be “unspecified”.
I’m especially concerned by the fact that people who know much more about Fed policy than I do are equally puzzled:
Andrew Levin, a former top Fed staffer and currently a Dartmouth College economic professor, said the Fed’s current rate-setting system is designed to attract deposits—with the 1.95% interest-on-reserves rate drawing them from banks and the 1.75% rate paid on its reverse-repurchase program drawing them from money-market investors. Through this program, the Fed sells a Treasury security to a participating firm and agrees to buy it back the next day with interest.
He said the Fed should welcome banks like TNB, adding they would make monetary policy work better because they would draw more from money-market investors. “The Fed should be excited about it and try to foster it,” he said.
The Fed seems reluctant to say no, as then it would have to specify its actual concerns. Rather they seem to be dragging out the process in the hopes that the proposal will be quietly dropped. Hence the lawsuit. I suspect the Fed believes that the actual reasons for its opposition would be politically unpopular.
READER COMMENTS
Michael Watts
Sep 9 2018 at 3:51am
I feel like Matt Levine’s recent piece, “Fed Rejects Bank for Being Too Safe” ( https://www.bloomberg.com/view/articles/2018-09-06/fed-rejects-bank-for-being-too-safe ), should probably be linked here.
Bruno Duarte
Sep 9 2018 at 9:24am
Interesting topic. Speculatively, a concern may be that these deposits are held in T-bills and hence inextricably linked to Fed auctions and setting the interbank ONR floor.
A second issue is liquidity drainage: were banks to compete with the Fed for deposits, a deposit interest rate floor would effectively shift both borrowing and lending rates at ckmmecicom banks to a less competitive value.
By restricting access, the Fed ensures banks capture a portion of their earnings when money is created rather than passing that cost through higher spreads to consumers.
A third issue may be unstable borrowing costs to government. As most individuals hold M0 for consumption instead of T-bills, primary buyers of government securities would demand higher yields to purchase the securities as not only would the interest rate and spread demanded and paid be customers be higher but also the volatility of more T-bills selling (as retail customers withdraw money from the Fed accounts, T-bills are sold) require a premia for unforeseen exogenous effects (eg collapsed external demand).
A fourth issue is the demand placed upon government to issue enough T-bills to cover foreign earnings of American firms paid as wages to workers on American soil. So the iPhone designer would be enticed to convert her earned Euros into dollars – and later into T-bills, internalising in government the effects of foreign commerce (not very libertarian).
A fifth and final concern is related to term deposits at the Fed. The deposits are meant to cover excess not ordinary liquidity beyond requirements. This means what money the economy doesn’t use/demand (right?) and the Fed can opportunistically use it to control money by stabilising the banks’ incentives to lend through term deposits and combining it with OMO to define money supply. If money in excess of requirements were deposited with the Fed in term deposits, it would undo the Fed’s control over money supply (fractional would stop working) and pass on the arbitrage function onto the consumer: whereas now the consumer chooses whether to spend, invest/save or borrow, it would in that case gain a fourth option – to lend. As competition would keep the interest margin for banks, individuals would now be enticed to lend funds because their returns (the Fed deposits rate) would be independent of their capital cost (either the opportunity-cost of spending or their borrowing rate at the local bank) as individuals are not required to hold a portion of assets at the Fed.
With the current system in place, this change would create new lending agents overnight that would easily undercut banks spreads and upend the financial system (we’d be very thankful for FDIC on such circumstance).
In a nutshell: truly bad idea to introduce this change without changing other parts of the system and completely understandable the Fed’s reticence – and even undisclosure as the debate would create arguments against lower government costs, controlled capital costs and money supply, a regulated banking activity and the function of banking as an unbiased distributor of wealth.
bill
Sep 9 2018 at 9:49am
I’m surprised that the people looking to start TNB USA didn’t just buy a very small bank. There are some really small ones out there, so within a short period of time the bank would be well over 90% what they are looking for. They could let the existing balance sheet run off or they could package it up and sell the pre-existing things within weeks of the purchase.
Scott Sumner
Sep 9 2018 at 7:36pm
Bruno, Sorry, I don’t follow your argument.
Bill, I’m told that that won’t work, but I’m not expert on the subject. These small banks are subject to certain regulations that don’t apply to a “narrow bank”.
Gordon
Sep 9 2018 at 7:46pm
I wonder if the Fed is wary of the TNB because of concerns for the next time we hit the ZLB. Suppose the TNB becomes popular and similar institutions come into being. Would a policy of negative IOR become more politically or technically difficult to implement? If an answer of “no” is not guaranteed, then allowing an institution like the TNB to move forward may be imprudent.
derek
Sep 10 2018 at 9:21am
This is what I was going to post as a suggestion for a good reason. The Fed may believe that this kind of policy would reduce its political independence.
bill
Sep 10 2018 at 2:23pm
I’d be curious to see how 2018 is turning out for the Fed. Politically, I’d guess that they do not want to operate at a loss which should make it harder for them to invert the yield curve. At least they will need to shrink their balance sheet first.
https://www.federalreserve.gov/newsevents/pressreleases/other20180110a.htm
Bruno Duarte
Sep 10 2018 at 6:17pm
Here’s what I found out Scott, correct me if you know better. (https://www.federalreserve.gov/releases/h41/current/)
Bank deposits with the Fed are held in T-Bills and serve a purpose: safely keep excessive liquidity. If retail customers were accepted as depositors on the Fed we could expect:
– increased volatility in Government borrowing costs;
– more government debt;
– a market floor to deposit interest rates;
– higher borrowing costs;
– new lending agents (consumers) whose deposit interest rate would now be independent of their borrowing cost (whereas typically a consumer would be paid and pay interest according to financial market liquidity, demand for loans and institutional profitability).
I think it’s a bad idea.
Sorry for the pigeon English.
Scott Sumner
Sep 10 2018 at 7:10pm
Gordon, I don’t see how this reduces the Fed’s ability to do monetary policy, even negative rates. And if that were the reason, then they should say so.
Bill, I doubt they will lose money, unless something weird happens. Don’t forget that their liabilities include $1.5 trillion in zero interest cash.
Gordon
Sep 10 2018 at 11:03pm
In theory, it may not affect monetary policy decisions. But didn’t public complaints about inflation cause the FOMC to proceed too cautiously with the first two rounds of QE? And if the FOMC fears an extremely ignorant response from Congress on negative IOR in the future, it probably wouldn’t be wise for them to point out they fear political interference that stems from the economic ignorance and incompetence of political leaders.
Scott Sumner
Sep 11 2018 at 2:12am
Gordon, I don’t think the Fed has any intention of doing negative IOR. But if I’m wrong and they do intend to do negative IOR in the next recession, then they need to announce that right now. Monetary policy is far more effective when it’s transparent and credible.
Now that we’ve had experience with QE, and Europe and Japan have done negative IOR, I doubt you’ll see much fear of the inflationary consequences of these actions. That view’s been discredited.
Timothy Hopper
Sep 11 2018 at 5:22am
Noting Andrew Levin’s comment on the narrow bank drawing money market investors, could Federal Reserve opposition to the narrow bank be as simple as not wanting to pay 1.95% on deposits which it currently pays 1.75% on through money market funds?
Is it correct that FDIC deposit insurance would also not be paid by the narrow bank? Is deposit insurance generally paid on the deposits earning 1.95% at the Fed, but not on the funds earning 1.75%?
Scott Sumner
Sep 12 2018 at 3:34pm
Timothy, I’m not sure, but those are very good questions.
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