Federal Reserve bank dividends became an unexpected point of contention after a Senate highway funding bill proposed reducing the dividend paid to certain banks that hold stock in the Federal Reserve System. The change was projected to generate billions of dollars over 10 years to help finance transportation spending, effectively making financial institutions a significant funding source for the legislation.
The proposal could have implications beyond reduced income for banks. Although the provision was characterized as targeting large institutions, the proposed asset threshold could also encompass many community banks. That raised concerns about whether reducing Federal Reserve bank dividends could change the economics of Fed membership for smaller financial institutions.
While bankers weren’t looking, a provision was slipped in the Senate’s highway funding bill that would make banks the single largest funding source of that bill. The language proposes to substantially reduce the benefit banks receive from the Federal Reserve to the tune of $17 Billion over the next 10 years.
When banks join the Federal Reserve system, they are required to buy stock in the central bank equal to 6 percent of their assets. However, that stock does not gain value and cannot be traded or sold, so to entice banks to participate, the Fed pays out a 6 percent dividend payment. The Senate proposal says it would slash that “overly generous” payout to 1.5 percent for all banks with more than $1 billion in assets. While the summary language outlining the proposal said that change would only impact “large banks,” industry advocates argued that banks who would most identify as small community shops could easily have assets in excess of that amount.
Community Banks Could Feel the Impact
Although bank lobbyists are now attacking the idea, it may be tough to overcome. Taxing banks to improve the highway system is probably a pretty easy sell.
Could Lower Dividends Affect Federal Reserve Membership?
Other than banks losing money, what is the impact of this proposed legislation? Janet Yellen, when asked to comment on the reduction in the dividend thought it could impact banks inclination to join the Fed:
“This is a change that likely would be a significant concern to the many small banks that receive the dividend,” she said.
The debate illustrates how a provision designed to generate revenue for an unrelated spending bill could have consequences for the banking system. For affected institutions, reducing Federal Reserve bank dividends would mean losing part of the return associated with the stock they are required to hold as members of the Federal Reserve System.
The broader question is whether that financial change could influence banks’ willingness to maintain or pursue Federal Reserve membership. With Janet Yellen acknowledging that the proposal could be a significant concern for smaller banks, the potential impact extends beyond the immediate revenue generated for highway funding and into the relationship between community banks and the Federal Reserve System.
Overview by Sarah Grotta, Director, Debit Advisory Service at Mercator Advisory Group
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