Re: Economic Dimensions

["John B. O'Donnell" <jackodonnell@xxxxxxxx>]

William F. Hummel wrote:
>
> 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.


I think I do recall that justification, but as you say, reserves
were [Are?] a drag on the banking industry. I thought there was a
change somewhere along the line that allowed banks to collect
interest on reserve deposits. It would be less than they could
earn from market loans, but at least not the zero it had been.
[Is?]

> 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.

And foreign competition is, of course, a very good reason to use
an alternative restraint on credit growth that does not put an
unproductive wedge between retail and wholesale interest rates or
otherwise unproductively increase the cost of loanable funds.

> 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.

Now it sounds even more familiar. Thanks for the recall. It's a
good thing I never tried to be an historian, I have trouble
remembering recent things I lived through.

			-- jbod
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