The Federal Reserve on Monday took two steps to boost liquidity amid the stalled credit markets, saying it would begin paying interest on bank reserves it holds and increasing the size of a securities lending auction program.
Banks are required to keep a reserve at the Fed. Paying interest on this money will give the central bank "greater scope to use its lending programs to address conditions in credit markets," eliminating the "opportunity cost" of holding the reserves and "promoting efficiency" among banks.
Also, beginning Monday with an auction of 84-day funds, the Fed will increase the size of its 84- and 28-day term auction facilities to $150 billion each. The increases will bring the amounts outstanding under the program to $600 billion each.
Congress two years ago had authorized the Fed to begin paying interest on bank reserves it holds in 2011, but the start of the program was moved up in the bailout legislation approved last week.The interest rate on required reserves will be 10 basis points less than the FOMC's average targeted federal funds rate over each reserve maintenance period. The Fed will pay 75 basis points less than the federal funds rate on excess reserves.