Fed raised rates. How does this lead to higher rates on consumer/corporate loans

[mcplums]

"The increase will be executed by raising the interest rate the Fed pays on excess reserves held by banks to 0.5 per cent, effective on December 17, as well as the use of an overnight reverse repurchase programme."

This is from FT.com. I don't understand it. In order for an increase in rates to be transmitted throughout the economy, shouldn't the rates the fed CHARGES on excess reserves go up!?

If they pay banks more for reserves held at the Fed then surely the banks can then lower the rates they charge their customers?

[odolvlobo]

The Fed pays 0.5% interest on excess reserves, so banks won't loan those excess reserves at less than 0.5%. Charging interest on reserves would be like charging interest on a saving account.

[deisik]

"The increase will be executed by raising the interest rate the Fed pays on excess reserves held by banks to 0.5 per cent, effective on December 17, as well as the use of an overnight reverse repurchase programme."

This is from FT.com. I don't understand it. In order for an increase in rates to be transmitted throughout the economy, shouldn't the rates the fed CHARGES on excess reserves go up!?

If they pay banks more for reserves held at the Fed then surely the banks can then lower the rates they charge their customers?

They could, but why would they risk defaults on the loans to their customers for rates lower than 0.5% if they can safely get just that from the Fed?

[medUSA]

If they pay banks more for reserves held at the Fed then surely the banks can then lower the rates they charge their customers?

Not really, banks can deposit reserves at the Fed and earn 0.5% interest, or they can loan to consumers and corporations. In order to make the loans worthwhile (risk of default), banks would charge a higher rate than the Fed's rate (risk free). This is a simplistic explanation, bank cashflow is a factor too, but I hope you get the idea.

[mcplums]

Thanks chaps you have totally answered my question here. I understand now!!

Out of interest, what are 'excess reserves', are they reserves beyond what the bank needs to comply with regulations? Like 10% of deposits for example?

And when the central bank pays interest, does the extra money come 'from' anywhere or is it printed?

My understanding is that all money created by the Fed has an asset to back it up (usually government loan) but sounds like this isn't true in the case of interest?

[mcplums]

Further to my previous question, I found this paragraph at wikipedia:

"On March 20, 2013, excess reserves stood at $1.76 trillion.[19] As the economy began to show signs of recovery in 2013, the Fed began to worry about the public relations problem that paying dozens of billions of dollars in interest on excess reserves (IOER) would cause when interest rates rise. St. Louis Fed president James B. Bullard said, "paying them something of the order of $50 billion [is] more than the entire profits of the largest banks." Bankers quoted in the Financial Times said the Fed could increase IOER rates more slowly than benchmark Fed funds rates, and reserves should be shifted out of the Fed and lent out by banks as the economy improves. Foreign banks have also steeply increased their excess reserves at the Fed which the Financial Times said could aggravate the Fed’s PR problem.[20]"

So it seems that the interest comes from taxpayers somehow, or am I misinterpreting? Also, they are paying interest from taxpayers to foreign banks!?!? Why isn't this bigger news?!

[bitart]

Central banks are not only taking deposits and paying interest for them, they are also involved usually in financing infrastructure projects. Those projects (building roads, pipelines, etc) are non profit investments and therefore the income is also limited from them. Because of this, commercial banks don't like to finance them because ofvthe lower marge possibilities. This is why central banks are financing these projects with limited marge long term loans. This interest is low but a bit higher than the interest of the excess reserves. This is just one possible income for central banks, so not all of the reserve interest is paid from the taxes of people