40% Of The Fed's Interest On Excess Reserves Is Paid To Foreign Banks

Even as both the Fed and Wall Street are gripped by a raging debate over when, how and how much the Fed should shrink its balance sheet, most appear to be ignoring the $2.1 trillion elephant in the room: the fact that every incremental increase in the Fed Funds rate (also an increase in the Interest On Excess Reserves, or IOER, currently at 1.25%) is a handout to US commercial banks, but that the direct recipient of this explicit Fed subsidy are a substantial number of foreign banks.

Here are the numbers:

  • as of the week of July 5, there were $2.1 trillion in reserves (of which the vast majority is "excess"), the largest liability by far on the Fed's $4.5 trillion balance sheet (currency in circulation is the other major component and amounts to $1.5 trillion).
  • as of the latest Fed rate hike, IOER is 1.25%

Putting these together, means that as of this moment, assuming no more rate changes, Janet Yellen will pay out $27 billion in interest on reserves parked with the Fed every year.

This much is known. What is less known, however, is the holding composition of these reserves, i.e., which banks have parked these $2.1 trillion in reserves with the Fed. Courtesy of the Fed's H.8 statement, however, we can quickly figure out.

Recall that as we showed first all the way back in 2011, the total cash on the books of commercial banks with operations in the US tracks the Fed's excess reserves almost dollar for dollar. More importantly, the number is broken down by small and large domestic banks, as well as international banks. It is the last number that is of biggest interest, because now that Congress is finally scrutinizing the $4.5 trillion elephant in the room, i.e., the Fed's balance sheet, it may be interested to know that approximately 40%, or $838 billion as of the latest weekly data, in reserves parked at the Fed belongs to foreign banks.

While we will reserve judgment, and merely point out that of the $100 or so billion in dividends and buybacks announced by US banks after the latest stress test a substantial amount comes directly courtesy of the Fed - cash that ultimately ends up in shareholders' pockets - we will note that the interest the Fed pays to foreign banks operating in the US who have parked reserves at the Fed, amounts to $10.4 billion annualized as of this moment.

This is a subsidy from the Fed, supposedly an institution that exists for the benefit of the US population, going directly and without any frictions to foreign banks, who - just like in the US - then proceed to dividend and buybacks these funds, "returning" them to their own shareholders, most of whom are foreign individuals.

While the number appears modest, it is poised to grow substantially as the Fed Funds rate is expected to keep growing, ultimately hitting 3.0% according to the Fed.

Indicatively, assuming excess reserves remain unchanged for the next 2-3 years and rates rise to 3.0%, that would imply a total annual subsidy to commercial banks amounting to $65 billion, of which $25 billion would go to foreign banks every year.

We wonder if this is the main reason why the Fed is so desperate to trim its balance sheet as it hikes rates, as sooner or later, someone in Congress will figure this out.

And as a tangent: considering that cash at US banks, most of which is parked at the Fed as reserves, amounts to just under $1.5 trillion, we wonder why the Fed does not simply cut off foreign banks' eligibility for its generous IOER subsidy, and make its balance sheet eligible only to US banks. It would slash its bloated balance sheet by over $800 billion overnight. Oh yes, that may actually test the widely accepted theory that banks outside the US are "safe."


NotApplicable NoDebt Thu, 07/13/2017 - 13:15 Permalink

Why wouldn't the IOER subsidy be eliminated as part of the Fed's "normalization" process? Edit: Answering my own question straight from the source.

The interest rate on required reserves (IORR rate) is determined by the Board and is intended to eliminate effectively the implicit tax that reserve requirements used to impose on depository institutions.According to the Policy Normalization Principles and Plans adopted by the Federal Open Market Committee (FOMC), during monetary policy normalization, the Federal Reserve intends to move the federal funds rate into the target range set by the FOMC primarily by adjusting the IOER rate. As indicated in the minutes of the March 2015 FOMC meeting, the Federal Reserve intends to set the IOER rate equal to the top of the target range for the federal funds rate.


In reply to by NoDebt

NotApplicable NotApplicable Thu, 07/13/2017 - 13:28 Permalink

And here's the initial justification from back in 2008.

The rate paid on excess balances will be set initially as the lowest targeted federal funds rate for each reserve maintenance period less 75 basis points. Paying interest on excess balances should help to establish a lower bound on the federal funds rate. The formula for the interest rate on excess balances may be adjusted subsequently in light of experience and evolving market conditions. The payment of interest on excess reserves will permit the Federal Reserve to expand its balance sheet as necessary to provide the liquidity necessary to support financial stability while implementing the monetary policy that is appropriate in light of the System's macroeconomic objectives of maximum employment and price stability.

So, it was done in order to allow for expansion of the balance sheet, yet it will increase as the Fed tries to shrink the balance sheet. Brilliant!https://www.federalreserve.gov/monetarypolicy/20081006a.htm

In reply to by NotApplicable

ShorTed NoDebt Thu, 07/13/2017 - 14:55 Permalink

The part that makes it really egregious is that it's not even their money. These foreigners (particularly the Nordic banks) are borrowing 30 to 40 bln per day from the mutual funds (overnight time deposits) @ 1.16% then turn around and lay it off on the Fed @ 1.25%, pocketing a risk free 75k - 100k per day.

In reply to by NoDebt

Justin Case peopledontwanttruth Thu, 07/13/2017 - 15:05 Permalink

USA is a corporation and yoa are an asset of that corporation, that the corporation borrowed money against yoar future labour. You were delivered to the corporation under maritime law and every Gov't issued document has to be in upper case to comply with that law. It says Statement of Birth, not certificate for a reason. A statement of delivery to the corporation as recieved.

In reply to by peopledontwanttruth

MEFOBILLS Yukon Cornholius Thu, 07/13/2017 - 14:08 Permalink

Founded by Hitler's finance minister BTW.________It always take effort to find out the real truth about things: Schact  (Hitler's finance minister) also used Sovereign money to run Hitlers economy. This would be the opposite of BIS control.  Germany had no great depression. During hyperinflation period (1921-24), the German central bank was privatized under America's Dawe's plan.  Schacht was called in to stop the hyperinflation, and to do that he created rentenmarks (against land), stopped local private banks from printing money, and only allowed FX against marks.  German central bank was de-privatized as well, to help stop the hyperinflaton and save Germany.Bank of International Settlements Schacht thought would be a way for Germany to help make Versaille Reparations, and was formed in 1930.  Schacht was still a "Gold" man in 1930, and also was learning Hebrew so could talk to Jewish International Bankers.  After Hitler's election in 1933, Hitler  ignored remaining Versaille debts.  Of course, the ((international)) had issues with that, as they wanted their pound of flesh.By the time 1938 rolled around, Schact was no longer a Gold Man and had a full grasp on how economies work.  He was not an economist by training, and started out as a banker.  A lot of what Schacht did was by intuition, as it had never been done before.   

In reply to by Yukon Cornholius

Peacefulwarrior Quivering Lip Thu, 07/13/2017 - 12:35 Permalink

This deflationary Economic situation is far worse than anyone on Earth can imagine, it's tentacles are far reaching and repurposed in many ways beyond our ability to see. They used economic weapons that NO one has ever seen before with implications that may give an Atomic Bomb a run for the money.These guys are cornered and are petrified of a prospective outcome if they use unilateral tightening strategy.

In reply to by Quivering Lip

I am Jobe Thu, 07/13/2017 - 12:18 Permalink

shhhhh. Sheeples are happy with Netflix and being glued to their phones. Can't be bothered with getting fucked over . It happnes in relationships. 

Justin Case Thu, 07/13/2017 - 12:18 Permalink

This is pandoras box.They want to off load the funds to the banks. The banks will want a yield on those funds. They will lend it out, but the amount will be multiplied by the fractional reserve requirements, which means there will be 10 times the amount the FED off loads. Maybe higher rates will curb consumer's appetite for borrowing? If rates move high enough then bonds are going to get whacked along with the stawk markets and many over inflated assets. Housing is one big bubble in Canada along with nose bleed high consumer debt. The banks are taking the stick to the piñata.This is the beginning of the end. The debt hang over. Batten down the hatches.