What is the Wednesday Scramble
BREAKING DOWN Wednesday Scramble
The Wednesday scramble takes place because the Federal Reserve issues reserve requirements for banks in order to ensure they have sufficient cash on hand to cover customer withdrawals. The Federal Reserve sets the rate as a percentage of a bank’s total deposits via a formula which adjusts thresholds for exemptions on an annual basis. The Fed uses the average reserve balance taken over a 14-day reserve maintenance period to calculate banks’ compliance with their reserve requirements. These periods begin on a Thursday and end on a Wednesday, which raises potential problems for a bank that reaches the end of the period and finds its average short of the reserve requirement. When that happens, banks must scramble to purchase additional reserves.
Banks add to their reserves by loaning funds to one another, so Wednesday scrambles can end up raising the federal funds rate if a large number of banks wind up seeking funds to add to their reserves. Conversely, a lack of a Wednesday scramble could suppress demand for interbank lending, causing a concomitant drop in the federal funds rate.
Excess Reserves and Liquidity
Excess reserves describe capital held by banks above the level of their required reserve. The Financial Services Regulatory Relief Act of 2006 gave the Federal Reserve the ability to offer interest on bank reserves and the financial crisis shortened the timeline for implementing these payments. The Fed pays banks different interest rates for required reserves and excess reserves. Paying interest on excess reserves (IOER) gives banks incentive to hold excess cash, taking risk out of the economic system and boosting liquidity in the interbank lending markets. The Federal Reserve pays interest in cash at a rate established by the Federal Open Market Committee (FOMC), which also establishes the target for the federal funds rate at which banks lend funds to one another.
Liquidity in the interbank lending markets plays an important role in keeping the economy running smoothly. The interbank lending freeze that followed the fall of Lehman Brothers during the financial crisis of 2008 generated widespread concern among regulators, to the point where central banks in Europe and the United States stepped in to thaw the markets. The Federal Reserve can take more pedestrian steps such as raising interest rates on excess reserves or reducing reserve requirements to increase liquidity in the financial system.