Fed to Conduct Series of Term Deposit Tests Next Month

The Federal Reserve said it plans a series of fixed-rate offerings of term deposits for banks beginning in October as it tests a facility designed to help it eventually raise interest rates.

The term deposits announced today will allow banks to withdraw funds early subject to a penalty, the Fed said. That means they would count as high-quality liquid assets banks are required to maintain to weather a financial crisis.

The Fed said it will conduct eight consecutive seven-day operations, which are designed to ensure the readiness of the Fed’s Term Deposit Facility, the central bank said today in a statement.

The facility was created in 2010 to help the Fed soak up cash from the financial system when the time comes to increase overnight borrowing costs, which have been held near zero since December 2008. Other tools include interest paid on excess reserves deposited with the Fed and a separate facility that borrows overnight from money-market mutual funds.

The Fed won’t raise its benchmark interest rate, known as the federal funds rate, until sometime next year, according to projections released in June.

The Fed said it expects the maximum award in the October offerings to increase to as much as $20 billion over the first four operations, with an interest rate of 0.26 percent. Over the next four, interest will probably increase to 0.3 percent in small steps, according to the statement. In a previous round of tests conducted from May to July, the maximum award was $10 billion.

Excess Reserves

The Fed pays 0.25 percent interest on excess reserves from banks and 0.05 percent to money funds in its reverse repurchase program.

The early withdrawal feature for term deposits would make the facility more attractive to banks, according to Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.

“Large banks would be able to treat the TDF as overnight cash in their LCR calculations, which would make them much more willing to participate,” he said in an e-mail, referring to liquidity coverage ratio, a measure of a bank’s access to cash and assets that can be quickly converted to cash. That would make it easier for the Fed “to immobilize a larger amount of reserves in ordinary circumstances,” Crandall said.

U.S. regulators yesterday adopted requirements for the level of high-quality, liquid assets banks must stockpile to survive a 30-day liquidity drought, a major step in efforts to prevent a repeat of the 2008 credit crisis.

Before it's here, it's on the Bloomberg Terminal.