[Update] Why Are Banks Holding So Many Excess Reserves?

11 Responses to [Update] Why Are Banks Holding So Many Excess Reserves?

1. jck says:

   December 28, 2009 at 5:25 pm

   “Reserve money is something different of deposit money.”
   Right, reserve money is an asset for the bank and a customer deposit is a liability for the bank.
2. vincent poncet says:

   December 28, 2009 at 4:40 pm

   My point might be taken as just a semantic point, but I think it is an important point about how it is actually working.
   Reserve money is something different of deposit money. Only banks can have reserve money. When looking the outcome of a lending by a bank to individual/corporation, for each $ created by a bank as deposit money (so called “lending”), that will transform $1/10 of its “excess reserve cash” into “reserve cash”. But the bank is not actually lending its reserve cash by lending to individual/corporation.

   When a bank a lending money to an individual/corporation, it is not actually lending something it as as asset, like reserve, but creating the amount as a claim on the deposit account on the customer deposit account which is in the liabilities of the bank, and put at the same time the claim on the customer as an asset in its balancesheet. On top of that, the central bank forces bank to has 10% (in US) of the amount of the created money by the bank as reserve, which is an asset of the bank and a liability of the central bank. But only the central bank can create/destroy reserve money and only banks can hold reserve money, cause only banks have an account at the central bank (and sometime treasury and GSEs in USA). If a bank create deposit money more than 10 times the amount it has as reserve money (assuming a 10% ratio), it needs to borrow it from the other reserve holders (banks), which could have an excess of reserve according to its own reserve requirements. That makes a market of federal fund loans, hence a market price of interest rate. So, if this market interest rate rise, that usually means banks are creating more deposit money than they are allowed by the current amount of reserve money and the reserve requirement ratio (could also be a disruption in the payment system, or a rise in risk perception between banks as we had in 2007). On top of that, current central banks have monetary policy of the interbank interest rate, that if the interbank market interest rate exceed the central bank intervention rate, the central bank will create reserve money and lend it, that way it will increase the total amount of reserve money and lower the interbank interest rate.
   So, the mecanism of reserve requirement/interbank interest intervension rate is the tool of central banks to limit/control of the creation of deposit money by banks.

   Since mid-2008, FED increased a lot the total amount of reserve (from $800B to $2T in a few months) mostly to monetize illiquid assets of banks and to ease mortgage/real estate markets. But banks did not created deposit money at the same rate. Real economy is not going well, they will not multiply by 2.5 their book of loans to already insolvent people/corporation. Hence, this new created reserve amount is “excess reserve” according to reserve requirement of banks.
3. jck says:

   December 27, 2009 at 10:14 pm

   Of course excess reserves can be lent but then, they are no longer just “excess”, part will become “required” reserves.
   If the money multiplier is operative, i.e. for $1 of required reserves there is roughly $9 of loan or securities purchased by banks (depending on the reserve ratio).
   If not operative, for $1 of excess reserves there is $0 new loans or securities purchased by banks, but these reserves could potentially be converted 100% into required reserves at any time if the money multiplier became operative and maxed out, i.e. banks resume increasing their balance sheet by lending or buying securities to the maximum permissible under reserve requirements.
   To go back to exhibit 1 and 2, there are excess reserve in 2 because the size of balance sheet of the banks has not changed, the central bank is acting as a clearing entity between banks in exhibit 2 something that was not necessary in normal times (exhibit 1) when the banks dealt directly with each other.
   “Lending excess reserves to people” is not perfectly semantically correct, because once lent (to the private sector) they are no longer 100% excess reserves.
4. vincent poncet says:

   December 27, 2009 at 9:02 pm

   Yes, I read it. That’s what I understand from this paper. So, I do not understand why we are talking about “holding reserves”, as reserves cannot be lent to people/corporations.
5. jck says:

   December 27, 2009 at 1:03 pm

   Look carefully at exhibit 1 and exhibit 2 and the text.
6. Poncet Vincent says:

   December 25, 2009 at 4:47 pm

   Tell me if I’m wrong, but I do not actually understand what “lending excess reserve to people/corporations” means.
   Here is how I understand the mecanism.

   Reserve cash is of different nature than common people/corporation cash.
   Only banks can have “reserve cash”.
   Only Federeal Reserve Bank can create or destroy reserve cash (by buying, lending, selling).

   Federal Reserve Bank imposes banks to hold reserve cash on their account of the Federal Reserve Bank to an amount of 10% of the total amount of banks customers’s deposit accounts.
   http://www.federalreserve.gov/monetarypolicy/reservereq.htm

   If a bank lacks reserve cash according to their reserve requirement, a bank can borrow from :
   - another bank, which has an excess reserve according to their reserve requirement. That means the other bank’s reserve cash will go from its own account at the fed to go to the borrowing bank reserve cash account at the fed,
   - people/corporations. That mean, their deposit cash account will be decreased to the amount lended/borrowed, and at the same time, the bank in which they have their deposit account will move the same amount but of reserve cash from its own account at the fed to the borrowing bank reserve cash account at the Fed.

   So, “excess reserve” is the amount of reserve cash which is above the 10% ratio.

   Technically, banks are not lending “excess reserve” to people/corporations. By “lending”, we have to understand that they are creating deposit money on the account of their customers.

   If Federal Reserve Bank is creating Reserve cash (by “lending” to banks, or buying financial assets) faster than the banks are creating deposit money (by “lending”, buying), there will be “excess reserve”. Even more, if banks are creating less deposit money than before.

   So, am I wrong to say that “lending excess reserve to people/corporations” has technically no meaning, and/or can be misleading about what actually happen ?
7. Being Alpha says:

   December 21, 2009 at 2:43 pm

   It seems like fear is a prevailing factor here. If no one knows just how much Excess Reserves are needed to maintain liquidity in the event of a loss of confidence and short-term funding, then most banking executives would naturally err on the side of caution — especially considering that regulators have taken a hardened stance to risk.
8. SPECTRE of Deflation says:

   December 20, 2009 at 4:21 pm

   You may want to look at the M1 Money Multiplier which is scraping new lows. The FED has an EPIC FAIL on their hands. Assume your crash positions, as the 1,3 and 6 month Bills indicate a crash upcoming.
9. David Pearson says:

   December 19, 2009 at 4:01 pm

   Weevie —

   Excess reserves are not capital. Asset impairments are hits on capital, and the excess reserves do not help in that situation. Where they do help is with liquidity: in the event of a loss of confidence and short term financing, banks can draw on ER’s to meet commitments. They are essentially no different than “cash” on a corporation’s balance sheet. The question is how much do banks need in precautionary cash balances? I don’t think anyone knows the answer, including the Fed.

   BTW, jck, I think this “research” piece is entirely political and self-serving. Let me sum up their message to politicians: “the fact that we through enormous amounts of money at the banking system and they didn’t lend it out is not evidence that our policy is ineffective”. I mean, come on. The banks can lend out these excess reserves, and they are not. The evidence is in the Fed’s own Bank lending statistics. Sure, when banks lend out ER’s, Required Reserves inch up and Excess Reserves decline only a little. That would be relevant if banks were lending, but obviously they are not.

   As for interest on reserves, they are an unlikely cause of carrying Excess Reserves. The markets are awash in the carry trade, which involves borrowing at zero and lending longer-term, or in different, higher yielding currencies. The banks can “borrow” Excess Reserves at an opportunity cost of .25% and do the same, in size. Are you telling me that the entire carry trade profitability is dependent on that incremental 25bp of spread? The implication is that the carry trade would collapse entirely if the Fed raised the FF target to 25bp and promised to leave it there forever. Not likely. The banks could make piles of money on an excess reserve carry trade, and the fact that they choose not to means that they are either 1) afraid of a rapid rise in rates; or 2) determined to keep the ER’s as precautionary liquidity balances.
10. Weevie says:

    December 19, 2009 at 11:54 am

    If the assets on a balance sheet aren’t worth what they are carried at, then ‘excess’ reserves aren’t truly excess. I believe that the so-called ‘excess’ reserves are being built up to put these banks in a position where they can be somewhat more honest about how impaired their assets really are.
11. dis says:

    December 18, 2009 at 7:14 pm

    perhaps because is paying interest on them.