Re: Economic Dimensions

[wfhummel@xxxxxxxxxxxxxx (William F. Hummel)]

John O'Donnell wrote:

><snip>
>
>The need for a formal requirement, however, does nothing to
>explain why the requirement is changed as is occasionally done by
>the FED. I can find no useful purpose for making these changes.
>Do you know of any?
>
There is a purpose behind adjustments of the reserve ratio
requirement, but I doubt that nowadays it is what the creators of
the Federal Reserve System had in mind when they wrote the act.

The Fed last changed the reserve ratio requirement in April 1992,
lowering the basic rate from 12% to 10%.   The Fed was anxious to
see more domestic bank lending after the credit crunch it created
in 1990-1991, but the change in reserve requirement had little to
do with that objective.  The change in 1992 was really motivated
by the desire to improve the financial health of U.S. banks.
Reserves are a drag on bank earnings since reserves earn no
interest.  Major banks in particular were not in good shape,
still plagued by large portfolios of bad loans made in the 1980s.
Also they were feeling the hot breath of foreign banking
competition which generally have no reserve requirements.  With
the lowered reserve ratio and the further lowering of the Fed
funds target rate [to 3.25% in July and 3.0% in October 1992] the
Fed provided a very strong boost to earnings of banks, and they
recovered nicely.

William F. Hummel