An Examination of the 1992 Increase in the Allowable Carryover of Reserves in the Bank Settlement Process

This paper examines the Federal Reserve's increase of the allowable carryover in the bank settlement process to improve bank flexibility in achieving settlement. The implication of increasing flexibility is reduced rate volatility. We find federal funds loan volume increases, but find no evidence of a reduction in federal funds rate volatility. These results are consistent with the increased carryover creating a profitable loan opportunity without changing the incentives that create the identified patterns in federal funds. We believe the difference between our results and the Federal Reserve's intention, derive from the difference in the trading behavior of the marginal and average bank.