FRBSF Economic Letter
2001-02; January 26, 2001
Retail Sweeps and Reserves
Western Banking Quarterly is a review of banking developments in
the Twelfth Federal Reserve District, and includes FRBSF's Regional Banking
Tables. It is normally published in the Economic Letter on
the fourth Friday of January, April, July, and October.
Since 1994, depository institutions have been able to lower required
reserves without affecting customer liquidity by periodically reclassifying
balances from retail transactions deposits into savings accounts. This
practice, known as "sweeping," has grown rapidly in the last
six years, and, as a result, reserve requirements as a percentage of total
liquid deposits have fallen dramatically.
This Economic Letter investigates the extent to which retail sweep
accounts are being used in the banking sector. We also investigate how
depository institutions have responded to the effective drop in required
reserves realized by sweeping.
The Federal Reserve requires depository institutions (DIs) to hold reserves
against transactions deposits, such as checking accounts. Currently, there
are no requirements for net transactions balances below $5.5 million,
and DIs must hold 3% reserves against balances between $5.5 million and
$42.8 million, and 10% against the remaining balances.
Depository institutions hold reserves in two forms: reserve balances
(deposits) at the Federal Reserve that earn no interest and vault cash
(vault cash includes the sum of all cash in central vaults, branches,
ATMs, and cash in transit with an armored carrier). Even without reserve
requirements, DIs would hold some reserves and vault cash to support the
transactions and liquidity services they provide to their customers. But
for many DIs, reserve requirements leave them holding more reserves than
they need for business purposes. For those DIs, reserve requirements are
like a tax, which they have incentives to reduce.
One way to reduce the reserve requirement tax is to use "sweep"
arrangements (for more detail on sweeps, see Edwards 1997). With sweeps,
balances in reservable accounts are periodically reclassified, or "swept,"
into money market deposit accounts, which are nonreservable accounts.
DIs have used sweeps for wholesale deposits for some time. Only since
1994, however, have DIs been permitted to sweep retail deposits. Since
then, the amount of retail deposits swept has grown significantly. By
December 1999, DIs were sweeping an estimated $370 billion (nearly 40%
of total liquid deposits). As a result of using sweeps, aggregate transactions
deposits fell from $810 billion in January 1994 to $620 billion by December
Large institutions (assets greater than $10 billion) account for much
of the sweeping. By the fourth quarter of 1998, nearly 70% of the large
institutions in a sample of 5,609 institutions in continuous operation
since 1994 had implemented sweep programs. Institutions that are medium-sized
(assets less than $10 billion and greater than $1 billion) and small (assets
less than $1 billion) adopted sweep programs at much lower rates—56%
and 8%, respectively.
Impact on reserves
Sweep arrangements have allowed DIs to maintain the liquidity of their
customers' accounts while lowering reservable deposit balances and thus
effectively reducing their reserve requirements. Given the reductions
in reserve requirements, it is interesting to ask whether DIs have changed
the way they meet reserve requirements. In other words, are DIs dividing
reserves in the same proportions between balances at the Federal Reserve
and balances in the form of vault cash?
In meeting reserve requirements, one advantage of holding balances at
the Federal Reserve is that excess reserves are highly liquid, since they
can be traded in the federal funds market. Vault cash holdings, in contrast,
are considerably less liquid than reserve balances, as the cost of transportation
effectively limits short-term trading. However, vault cash supports the
provision of liquidity services by DIs, and, therefore, additional vault
cash can have some value to a DI.
Figure 1 shows aggregate trends in the disposition
of reserves and vault cash in the sample as DIs reduced their reserve
requirements through retail sweeps. The ratio of vault cash to liquid
deposits remained relatively flat, while the ratio of reserve balances
at the Federal Reserve to liquid deposits (thin solid line) fell sharply.
On the surface, this suggests that, for the most part, vault cash holdings
tended to reflect the business needs of DIs and that the reserves in excess
of business needs were less costly to hold as reserve balances at the
Figures 2 and 3 break the sample down by separating the large DIs into
those that do and do not use retail sweeps as of 1999. It is clear from
Figure 2 that the relative reduction in reserve
balances at the Federal Reserve was much more pronounced for the DIs using
sweeps. As of the second quarter of 1999, large sweeping DIs held reserve
balances equal to approximately 1.5% of total liquid deposits (adjusted
transactions deposits). This supports the view that the adoption of sweeps
led to the adjustment to reserve balances.
Large DIs adopting sweeps also may have responded to the lower effective
reserve requirement by adjusting vault cash by more than suggested by
Figure 1. In Figure 3, the ratio of vault
cash to liquid deposits has fallen for the group of large DIs that adopted
retail sweeps. The decline in the ratio of the sweeping DIs is even more
notable when compared to the pronounced upward trend in the vault cash
ratios for the large non-sweeping DIs. Interestingly, while large sweeping
institutions appear to have managed declines in vault cash ratios, they
remain relatively more cash-intensive than their non-sweeping competitors.
Nevertheless, the sum of reserve balances at the Federal Reserve and vault
cash relative to transactions deposits (adjusted for sweeps) at the large
sweeping DIs has dropped below the comparable ratio for the non-sweeping
Retail sweeps afford DIs the opportunity to reduce the "tax"
from reserve requirements without reducing the liquidity of their customers'
accounts. The DIs adopting retail sweeps in recent years, as a group,
have been very successful in reducing the cost of reserve requirements.
Based on the adjustment made to date, it appears that DIs generally found
it less costly on the margin to meet binding reserve requirements by holding
balances at the Federal Reserve, rather than in the form of additional
vault cash. This may be because balances held at the Federal Reserve can
be managed more effectively. Nevertheless, the large DIs that engage in
retail sweeps also appear to have tightened the management of vault cash.
Edwards, Cheryl L. 1997. "Open Market Operations in the 1990s."
Federal Reserve Bulletin (November) pp. 859-874.
Opinions expressed in this newsletter do not necessarily reflect
the views of the management of the Federal Reserve Bank of San Francisco
or of the Board of Governors of the Federal Reserve System. Editorial
comments may be addressed to the editor or to the author. Mail comments
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