Fed 2016 profits to Treasury fall as interest to banks jumps

WASHINGTON (Reuters) - The interest paid by the Fed to major banks last year jumped to $12 billion as the central bank's chief tool for raising rates nationally provided a boon to some of the country's largest financial institutions.

In preliminary estimates of its 2016 results, the Fed said that its year-end remittances to the U.S. Treasury are expected to fall to $92 billion, down $5.7 billion from a record $97.7 billion transferred in 2015.

Part of the decline is due to a drop of about $2.6 billion in what the Fed earns on its holdings of U.S. Treasury bonds and mortgage-backed securities accumulated in fighting the 2007 to 2009 financial crisis.

But most of it is a result of the interest paid on excess reserves held by commercial banks at the 12 regional Federal Reserve institutions. Banks are required to hold some reserves, but are allowed to deposit more if they choose.

Between more cautious lending and weak economic growth, total reserves have been at historically high levels since the financial crisis -- roughly $2 trillion as of the end of the last year compared with a few billions of dollars in more typical times.

When the Fed increased its target interest rate in Dec. 2015 by a quarter of a percentage point, to a range of between 0.25 and 0.5, it increased the rate paid to banks as well - and pushed its overall reserve interest costs from $6.9 billion in 2015 to $12 billion last year.

The increase may draw attention from lawmakers who have been critical of the Fed paying money to large commercial institutions. The central bank argues that the payments are its most effective way to push rates higher: by offering interest on excess reserves, the Fed forces banks to raise the rate at which they are willing to lend to each other.

In theory, the interest paid on excess reserves should decline as the recovery proceeds and banks find better things to do with excess deposits than parking them at the central bank.

The annual remittances to the Treasury, though less than last year, are still nearly three times what they were in the years before quantitative easing led the Fed to accumulate what is now a $4 trillion balance sheet.

The Fed funds its operations through its earnings.

Its expenses were $709 million, up slightly from the $705 million in 2015.

(Reporting by Patrick Rucker and Howard Schneider; Editing by Paul Simao and Alan Crosby)