New Bill Bans the Fed from Paying Banks Interest on Deposits: What This Means for Your Bank’s Bottom Line

The “End the Fed’s Big Bank Bailout Act” is short, but it packs a punch. It targets one of the Federal Reserve’s most important tools for managing the economy: the interest rate it pays commercial banks on the money they keep parked at the Fed. The bill’s core action is simple and direct: it mandates that the Federal Reserve must stop paying any interest or earnings on the reserve balances that banks—officially called depository institutions—hold with it (SEC. 2).

The Interest on Reserves Tool: A Quick Explainer

To understand why this matters, think of the Fed as the bank for banks. When the Fed wants to manage the money supply and influence short-term interest rates, it uses a few levers. Since the 2008 financial crisis, paying Interest on Reserves (IOR) has become the primary way the Fed controls the federal funds rate—the rate banks charge each other for overnight loans. When the Fed pays interest on these reserves, it sets a floor for that rate, giving banks a risk-free return on their cash. This tool is critical for modern monetary policy, especially since the Fed started keeping large amounts of reserves in the system.

Who Feels the Pinch?

If this bill passes, the immediate impact is on the banks themselves. Currently, banks earn billions in interest annually from the Fed just by holding their required and excess reserves. Eliminating IOR means banks suddenly lose a reliable, risk-free revenue stream (SEC. 2). For a large bank, this is a significant hit to profitability. For the rest of us, this loss of income could translate into changes in how banks operate. They might try to make up the difference by charging consumers higher fees for checking accounts, increasing interest rates on loans like mortgages and credit cards, or reducing the interest they pay on savings accounts.

The Fed’s Missing Lever

This bill doesn't just affect bank profits; it handcuffs the Federal Reserve’s ability to manage the economy. Removing the IOR tool eliminates the Fed’s main way to influence short-term rates in the current financial environment, which is characterized by “ample reserves.” Without the ability to pay interest, the Fed loses its control over the floor of the federal funds rate. This could lead to greater volatility in short-term money markets, making it harder for the Fed to keep inflation or recessionary pressures in check. While proponents of this bill argue that paying IOR is an unnecessary subsidy to big banks, the practical cost is stripping the Fed of its most effective day-to-day monetary control mechanism.

The Real-World Trade-Off

For the average person juggling a mortgage and monthly bills, this bill presents a classic trade-off. On one hand, the bill aims to end what some see as a government subsidy to the financial sector, potentially reducing the Fed’s liabilities. On the other hand, the practical effects could be costly: your bank might charge you more for services or offer you less for your savings to recoup lost income, and the Fed’s reduced control over interest rates could increase the risk of economic instability. In short, while the goal is to target “big bank bailouts,” the fallout could mean higher costs for consumers and a more unpredictable economy.