The
demand for Federal Reserve balances has three components: required reserve
balances, contractual clearing balances, and excess reserve balances.
Required Reserve Balances
Required reserve balances are balances that a depository institution must hold
with the Federal Reserve to satisfy its reserve requirement. Reserve
requirements are imposed on all depository institutions which include commercial
banks, savings banks, savings and loan associations, and credit unions as well
as
Contractual
Clearing Balances
Depository institutions use their accounts at Federal Reserve Banks not only to
satisfy their reserve balance requirements but also to clear many financial
transactions. Given the volume and unpredictability of transactions that clear
through their accounts every day, depository institutions seek to hold an
end of day balance that is high enough to protect against unexpected debits that
could leave their accounts overdrawn at the end of the day and against any
resulting charges, which could be quite large. If a depository institution finds
that targeting an end of day balance equal to its required reserve balance
provides insufficient protection against overdrafts, it may establish a
contractual clearing balance (sometimes referred to as a required clearing
balance).
A contractual clearing balance
is an amount that a depository institution agrees to hold at its Reserve Bank in
addition to any required reserve balance. In return, the depository institution
earns implicit interest, in the form of earnings credits, on the balance held to
satisfy its contractual clearing balance. It uses these credits to defray the
cost of the Federal Reserve services it uses, such as check clearing and wire
transfers of funds and securities. If the depository institution fails to
satisfy its contractual requirement, the deficiency is subject to a charge.
Excess Reserve
Balances
A
depository institution may hold balances at its Federal Reserve Bank in addition
to those it must hold to meet its reserve balance requirement and its
contractual clearing balance. These balances are called excess reserve balances
(or excess reserves). In general, a depository institution attempts to keep
excess reserve balances at low levels because balances at the Federal Reserve
do not earn interest. However, a depository institution may aim to hold some
positive excess reserve balances at the end of the day as additional protection
against an overnight overdraft in its account or the risk of failing to hold
enough balances to satisfy its reserve or clearing balance requirement. This
desired cushion of balances can vary considerably from day to day, depending in
part on the volume and uncertainty about payments flowing through the
institution’s account. The daily demand for excess reserve balances is the
least predictable component of the demand for balances.