The impact of the return to lagged reserve requirements on the federal funds market

Abstract

We examine the impact on the settlement Wednesday effect in daily fed funds rates following the change from contemporaneous reserve requirements (CRR) to lagged reserve requirements (LRR). The Federal Reserve changed from CRR to LRR, in part, to make it easier for banks to settle their reserve accounts. Our hypothesis is that the switch to LRR will reduce the demand for reserves on settlement Wednesdays, thus reducing the settlement Wednesday effect in fed funds rates. Our empirical results provide strong support for our hypothesis.

Month-End Regularities in the Overnight Bank Funding Markets

“…To the extent that the regularities in the federal funds market exist because of regulatory reasons, changes in the regulatory and accounting conventions should directly impact these patterns. Kotomin and Winters (2007) provide evidence of the dissipation of the settlement Wednesday effect in the federal funds market post July 1998. The authors argue that the Federal Reserve's regulatory change from contemporaneous to lag reserve requirements (CRR to LRR) made it easier for banks to settle their reserve accounts.…”

“…Extending Spindt and Hoffmeister (1988), Griffiths and Winters (1995) find rate change regularities across the reserve maintenance period with fed funds rates declining on Fridays and increasing every second Wednesday (settlement Wednesday). However, Kotomin and Winters (2007) document the dissipation of the settlement Wednesday effect in the federal funds market post July 1998, due to Federal Reserve's regulatory change from contemporaneous to lag reserve requirements. With the understanding that previous regularities in fed funds come from regulations and with these studies as the backdrop, in this paper, we document a new regularity in the overnight fed funds markets.…”

Operational outages and aggregate uncertainty in the federal funds market

“…One thing that is quite different from results presented elsewhere is that during this sample period, funds consistently trade below the target rate on settlement day. While studies such as Hamilton (1996Hamilton ( , 1997 found that funds traded firm on settlement day, more recent studies including Taylor (2001) and Kotomin and Winters (2007) have found that funds tend to trade below the target rate on settlement day. Reasons for this switch include the implementation of lagged reserve accounting in 1998.…”

A regime-switching term structure model with observable state variables

“…However, since August 1998, a ''lagged reserve maintenance system" has been implemented. Kotomin and Winters (2007) provide empirical evidence on the time series properties of the FF rate within the old and new settlement mechanisms. They contend that the FF rate demonstrates a much smoother behavior after July 1998, and notice that the ''settlement Wednesday effect" has vanished.…”