November 11, 1993

Uncompensated Reserve Requirements: The Hidden Tax on Our Banks

Download Background Paper No. 6

Background Paper No. 6

Executive Summary Beginning with the National Bank Act of 1863, the federal government has required a substantial segment of the banking industry to hold idle a specified fraction of their deposits. These idle balances are known as required reserves. Starting in 1914, when Congress established the Federal Reserve System, banks —and after 1980, all depository institutions —have had to keep some measure of their required reserve balances as deposits at the Federal Reserve (the Fed).

Congress has never permitted the Fed to make compensating interest payments on banks ‘ required reserve deposit balances. Consequently, legal reserve requirements have acted as a hidden tax on banks, because these requirements reduce banks’ earnings by the amount of income they must forego.

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