[kallanwelsh]

The Bank of Japan recently took interest rates negative in a surprise move. How exactly does that work? Is this the equivalent of the federal funds rate? If the BOJ is charging 0.1% to park funds there, can’t the banks just hang onto the cash instead? Or are banks required to put all their excess reserves at the BOJ?

[jmherbener]

According to the Bloomberg report, the BoJ has set the “interest rate” it charges commercial banks on “new” reserve balances that they hold at the BoJ.

http://www.bloomberg.com/news/articles/2016-01-29/bank-of-japan-s-negative-interest-rate-decision-explained

The BoJ is not the only central bank that is currently charging commercial banks for adding to their excess reserve balances. These charges, the BoJ’s is 0.1 percent, are not interest rates at all but fees designed to prevent commercial banks from continuing to build their excess reserve positions. The BoJ hopes that commercial banks will begin to make more loans instead of building up their excess reserves.

The Federal Reserve has a similar policy of paying “interest” on commercial bank reserves. Like the BoJ, the Fed has two tiers of “interest” it pays, one rate on required reserves and one rate on excess reserves. Currently the Fed has both “rates” set at 0.50 percent.

http://www.federalreserve.gov/monetarypolicy/reqresbalances.htm

The Federal Funds rate is an actual interest rate, namely, the one on inter-bank, over-night loans. The Fed targets this interest rate when conducting monetary policy because they consider it a gauge of the scarcity of reserves in the banking system. Federal funds loans are the trade of reserves among banks. The Fed manipulates this rate by supplying more reserves to banks through open market operations. The Fed assesses the degree of monetary expansion from such policy by watching the Federal Funds rate.

[kallanwelsh]

1) Can private banks just *not* put their money (beyond required reserves and whatever healthy margin they need) at the central bank, and thus avoid paying the 0.1% fee while simultaneously not using the money to extend loans?

2) If the Federal Reserve is targeting 0.25%-0.50% for the federal funds rate, why would any banks extend overnight loans for less than 0.50% if the Federal Reserve is paying 0.50% on excess reserves? (According to this https://apps.newyorkfed.org/markets/autorates/fed%20funds the most recent daily rate averaged 0.38%.) Why are banks extending loans at 0.38% when they can keep the funds parked at the Fed for 0.50%?

Thank you.

[jmherbener]

(1) The BoJ is only charging the fee of 0.1 percent on additional excess reserves. So the excess reserves balances that commercial banks had before the announcement a few weeks ago are not subject to the fee. Of course, commercial banks could choose not to increase their excess reserves, that is what the BoJ is trying to bring about with its new policy.

What concerns central banks is that allowing commercial banks to build up and run down excess reserves reduces the control a central bank has over the money supply. When banks are fully loaned up, holding no or minimal excess reserves, then open market operations by central banks have a more predictable impact on the money supply through the so-called money multiplier. But, if commercial banks sell securities to their central bank and hold the funds as excess reserves or part of the funds as excess reserves, then the effect of the central bank’s purchase of securities from commercial banks is less predictable, i.e., less under the control of the central bank.

By charging commercial banks for additional funds that they hold as excess reserves, the BoJ is trying to put an upper limit on the building up of excess reserves by commercial banks. The BoJ hopes that from now on when it buys securities from commercial banks, they will respond by extending loans on top of the additional reserves. In other words, the BoJ is hoping that commercial banks treat the funds received from selling securities to the BoJ as required reserves instead of excess reserves.

(2) U.S. commercial banks are not the only participants in the Federal Funds market. The residual activity in the Fed Funds market is likely being conducted by foreign banks, government-sponsored enterprises, or other eligible entities.

https://www.newyorkfed.org/aboutthefed/fedpoint/fed15.html

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