Federal reserve float

What Is Federal Reserve Float?

Federal Reserve float refers to the temporary, duplicate money that exists within the banking system due to delays in the processing and settlement of payments, primarily checks, by the Federal Reserve. This phenomenon falls under the broader financial category of Monetary policy and Banking operations. It arises when the Federal Reserve credits the reserve accounts of depository institutions that deposit checks before it has collected the corresponding funds from the banks on which those checks are drawn.³⁸ In essence, during the time lag, the funds are counted both in the depositing bank's reserves and in the paying bank's account, creating a temporary increase in the system's total reserves.³⁷ While less prominent today due to advances in electronic funds transfer, Federal Reserve float was historically a significant factor in managing the money supply.

History and Origin

The concept of float emerged with the widespread use of checks in the payment systems. Before the Federal Reserve's involvement, check clearing was a fragmented and often slow process, leading to delays as checks physically moved between banks.³⁶ When the Federal Reserve System was established in 1913, one of its core responsibilities became providing an efficient nationwide check clearing service.³⁵ However, the very act of guaranteeing credit availability to payee banks based on fixed schedules, even if actual collection from payor banks was delayed, naturally gave rise to Federal Reserve float.³⁴

Throughout the 20th century, Federal Reserve float fluctuated, often increasing during periods of high check volume or transportation delays (e.g., due to weather).³², ³³ A notable surge in float occurred in the late 1970s, reaching a daily average of $6.6 billion in 1979.³¹ This increase was partly attributed to rising interest rates, which incentivized companies to engage in practices like "remote disbursement," where checks were drawn on distant banks to intentionally maximize the time it took for them to clear, allowing the funds to earn interest for longer.²⁹, ³⁰ The significant rise in Federal Reserve float prompted congressional attention and ultimately led to the passage of the Monetary Control Act of 1980 (MCA-80).²⁸ This act mandated that the Federal Reserve charge for its payment services and, crucially, price any remaining float.²⁷ The Fed's subsequent actions, including operational improvements and the pricing of float at the federal funds rate, significantly reduced float levels in the years following the MCA-80.²⁵, ²⁶

Key Takeaways

• Federal Reserve float is the temporary "double-counting" of money in the banking system during the check clearing process.
• It arises when the Federal Reserve credits a depositing bank's account before it has debited the paying bank's account.²⁴
• Historically, float could significantly impact the total level of bank reserves in the financial system.²³
• The Monetary Control Act of 1980 (MCA-80) led to measures that drastically reduced and priced Federal Reserve float.²²
• With the rise of electronic payment methods, the magnitude and significance of Federal Reserve float have diminished considerably.

Formula and Calculation

Federal Reserve float is formally defined as the difference between two key items on the Federal Reserve's balance sheet: Cash Items in the Process of Collection (CIPC) and Deferred Availability Items (DAI).²¹

• Cash Items in the Process of Collection (CIPC) represents the value of checks that the Federal Reserve has received and is currently processing but for which it has not yet collected payment. This is an asset for the Federal Reserve.²⁰
• Deferred Availability Items (DAI) represents the value of checks for which the Federal Reserve has already granted credit to the depositing bank but has not yet received the funds from the paying bank. This is a liability for the Federal Reserve.¹⁹

The formula for Federal Reserve float is:

$\text{Federal Reserve Float} = \text{CIPC} - \text{DAI}$

In practice, CIPC typically exceeds DAI, resulting in a net positive float, meaning there's a net addition to total bank reserves.¹⁸

Interpreting the Federal Reserve Float

Interpreting Federal Reserve float historically involved understanding its impact on the aggregate level of bank reserves within the banking system. A positive Federal Reserve float essentially provides an interest-free loan to the banking system, as banks gain credit for funds before the Federal Reserve has collected them.¹⁷ This temporary increase in reserves could influence the availability of funds for lending and, consequently, short-term interest rates. The Federal Reserve's Trading Desk, responsible for conducting open market operations, closely monitored float as it was one of the most volatile factors affecting reserves. Large, unpredictable movements in float could complicate the Fed's ability to maintain its desired level of reserves and execute monetary policy targets.¹⁵, ¹⁶ Today, with significantly reduced float levels, its direct impact on day-to-day reserve management is minimal compared to other factors like the Treasury General Account (TGA) or currency demand.¹⁴

Hypothetical Example

Imagine it's a busy Monday morning. A regional bank, "First National," receives a large check deposit for $1 million from a corporate client. The check is drawn on "Global City Bank," located in a different Federal Reserve district.

1. Deposit and Credit: First National processes the check and sends it to its local Federal Reserve Bank branch. Based on the Federal Reserve's availability schedule, First National's reserve account at the Federal Reserve is credited for the $1 million later that day.
2. Processing Delay: Due to high volume or a minor transportation delay, the physical or electronic image of the check takes an extra day to reach Global City Bank's Federal Reserve branch and, subsequently, Global City Bank itself.
3. Float Creation: During this delay—from the moment First National's account is credited until Global City Bank's account is debited—the $1 million temporarily appears as available funds in both banks. This temporary duplication represents $1 million in Federal Reserve float.
4. Settlement: The next day, Global City Bank receives the check information, verifies the funds, and its Federal Reserve account is debited. At this point, the Federal Reserve float related to this specific check is eliminated as the funds are no longer "double-counted."

This example illustrates how temporary delays in the check clearing process, even for a single item, contribute to the overall Federal Reserve float.

Practical Applications

Historically, Federal Reserve float had several practical implications:

• Monetary Policy Management: For the Federal Reserve, understanding and forecasting float was crucial for conducting effective monetary policy. Unpredictable swings in float could inject or withdraw a significant amount of bank reserves, requiring the Fed to conduct offsetting open market operations to maintain its desired target for reserves and the federal funds rate.
• ¹², ¹³ Bank Liquidity: For individual depository institutions, Federal Reserve float could impact their daily liquidity. Banks receiving early credit could use these funds, effectively getting an interest-free loan, while paying banks would have a temporary delay before their reserves were debited.
• Corporate Cash Management: In the past, large corporations used cash management strategies like remote disbursement to take advantage of the float, delaying payment and retaining use of funds for a longer period. This practice, known as "transportation float," allowed companies to invest their cash for an extended time.

Wh¹¹ile its direct impact has lessened, the Federal Reserve continues to monitor various factors affecting the payment system, including float, as part of its broader oversight role. Data on Federal Reserve float is still published by entities like the Federal Reserve Bank of St. Louis, which provides historical levels via its FRED database. The¹⁰ Federal Reserve's role in the payment system continues to evolve, adapting to new technologies and payment methods.

##⁹ Limitations and Criticisms

While an inherent byproduct of the check clearing system, Federal Reserve float presented several limitations and criticisms, primarily concerning its impact on monetary policy and its potential for misuse.

One key criticism was that Federal Reserve float represented an implicit, interest-free subsidy to the banking system. Bec⁸ause banks were credited before the Fed collected funds, they effectively received an interest-free loan of reserves. This subsidy had to be financed by Treasury revenues, ultimately borne by taxpayers.

Fu⁷rthermore, the unpredictable nature of Federal Reserve float made it challenging for the Federal Reserve to manage bank reserves precisely. Fluctuations caused by factors like weather, processing backlogs, or geographic distances between banks could lead to unintended increases or decreases in the total level of reserves, complicating the implementation of open market operations.

Pe⁶rhaps the most significant criticism arose from the potential for abuse. The time lag associated with float could be exploited through practices like check kiting, where individuals or entities would write checks against insufficient funds in one bank, depositing them in another, and relying on the float period to deposit funds to cover the first check before it cleared. A prominent example of such misuse was the E.F. Hutton wire fraud case in 1985, where the brokerage firm pleaded guilty to deliberately overdrawing accounts to profit from the float, effectively obtaining unauthorized, interest-free loans from banks. This incident highlighted the need for stricter controls and pricing mechanisms to deter such activities, ultimately contributing to the policy changes brought about by the MCA-80.

Federal Reserve Float vs. Bank Reserves

While related, Federal Reserve float and bank reserves are distinct concepts in finance.

Bank reserves refer to the cash that commercial banks hold in their vaults or as deposits at the Federal Reserve. These are actual funds that banks are required to hold (required reserves) or choose to hold in excess (excess reserves) to meet withdrawal demands, clear payments, and satisfy regulatory requirements. Bank reserves represent a portion of the money supply that is held by banks and is fundamental to the banking system's liquidity and the Federal Reserve's control over credit.

Federal Reserve float, on the other hand, is a temporary accounting phenomenon. It's not a physical pool of money, but rather a short-term duplication of money on the books within the payment systems. It occurs when the Federal Reserve grants provisional credit to a depositing bank (increasing its reserves) before it has successfully collected the funds from the paying bank (decreasing that bank's reserves). Thi⁵s delay means that for a brief period, the same money is effectively counted twice. While an increase in Federal Reserve float adds to the total level of bank reserves in the system, it is a volatile and often unintended byproduct of the payment clearing process, rather than a stable component of a bank's reserve holdings.

The key difference lies in their nature: bank reserves are a stock of actual funds held by banks, whereas Federal Reserve float is a temporary, transactional anomaly resulting from timing differences in the clearing process that affects the aggregate level of reserves.

FAQs

How does the Federal Reserve reduce float?

The Federal Reserve has reduced float through a combination of measures, including improving the efficiency of its check clearing operations, implementing availability schedules that more closely align credit with collection times, and, most significantly, pricing float. The pricing mechanism, introduced after the Monetary Control Act of 1980, charges depository institutions interest for the reserves provided as float. The³, ⁴ advent of electronic funds transfer and image-based check processing (like Check 21) has also drastically reduced the time checks spend in transit, further minimizing float.

##²# Is Federal Reserve float still relevant today?
While Federal Reserve float has significantly decreased due to advancements in electronic payment technologies, it remains a theoretical concept and a small component of the Federal Reserve's balance sheet that is still monitored. The rise of instant payment systems continues to reduce the relevance of physical check-based float, but the underlying principle of timing differences in financial transactions can still create similar, albeit smaller, temporary imbalances.

Can individuals benefit from Federal Reserve float?

In the past, some individuals and businesses could strategically time their deposits and payments to take advantage of the float, allowing them to keep funds in their accounts longer or earn interest on funds that had technically been spent but not yet cleared. How¹ever, with electronic payments and faster check clearing processes, the window for such practices has largely disappeared for the average consumer. Engaging in such activities today, especially if it involves writing checks without sufficient funds, could lead to significant overdraft fees or even legal consequences like check kiting.