In response to Free Money! Banks Paid $22 Billion to Not Lend? I received a comment from economist Professor George Selgin who said I do not know what I am talking about.
Selgin made similar comments about Chris Whalen, Chairman of Whalen Global Advisors LLC, in two supporting links.
I also received a Tweet from economist Professor Steve Keen who said: “Mish Nails It“.
Both viewpoints cannot be right. Let’s explore competing viewpoints on lending excess reserves, banks hoarding cash, and free money banks receive from the Fed for interest on excess reserves.
Mish Statements
Excess reserves are a function of the Fed’s balance sheet and those reserves do not change whether a bank lends more or not.
There is no “demand” for excess reserves. Rather, the Fed has crammed excess reserves into the system and has decided to pay interest on them.
- Mathematically speaking, excess reserves cannot spur lending.
- Banks are not paid $22 billion to “not lend” $2.2 trillion as many contend.
- Banks are paid $22 billion because the Fed decided to do so.
Whether or not banks lend has nothing to do with interest on excess loans. Rather, the decision to pay interest on excess reserves is simply $22 billion in free money to banks every year, at taxpayer expense.
Steve Keen
Selgin: Interest on Reserves
In Interest On Reserves, Part II, Selgin writes.
Of the many bemusing chapters of the whole interest-on-reserves tragicomedy, none is more jaw-droppingly so than that in which the strategies’ apologists endeavored to show that paying interest on reserves did not, after all, discourage banks from lending, or contribute to the vast accumulation of excess reserves.
But let us set our befuddlement aside, in order to allow our authors to dispute the view that the vast post-IOR accumulation of excess reserves was evidence that the Fed’s emergency loans and asset purchases weren’t serving to “maintain” an adequate flow of credit:
To the contrary, the level of reserves in the banking system is almost entirely unaffected by bank lending. By virtue of simple accounting, transactions by one bank that reduce the amount of reserves it holds will necessarily be met with an equal increase in reserves held at other banks, and vice versa. As described in detail in a 2009 paper by New York Fed economists Todd Keister and James McAndrews, nearly all of the total quantity of reserves in the banking system is determined solely by the amount provided by Federal Reserve. Thus, the level of total reserves in the banking system is not an appropriate metric for the success of the Fed’s lending programs.
A gold star to all who spot the fallacy here. For those who can’t, it’s simple: “reserves” and “excess reserves” aren’t the same thing. Banks can’t collectively get rid of “reserves” by lending them — the reserves just get shifted around, exactly as Walter and Courtois suggest. But banks most certainly can get rid of excess reserves by lending them, because as banks acquire new assets, they also create new liabilities, including deposits. As the nominal quantity of deposits increases, so do banks’ required reserves. As required reserves increase, excess reserves decline correspondingly. It follows that an extraordinarily large quantity of excess reserves is proof, not only of a large supply of reserves, but of a heightened real demand for such, and of an equivalently reduced flow of credit.
IOER and Banks’ Demand for Reserves, Yet Again
Here are some Selgin snips from IOER and Banks’ Demand for Reserves, Yet Again.
In our recent American Banker opinion piece, Heritage’s Norbert Michel and I argue that, if the Fed is really serious about shrinking its balance sheet, it had better quit paying interest on banks’ excess reserves (IOER) as well. How come? Because the current, relatively high IOER rate is contributing to a strong overall demand for excess reserves, while a shrunken Fed balance sheet will mean a reduced supply of reserves. Reducing the supply of reserves while doing nothing to reduce banks’ demand for them is a recipe for demand-driven deflation, which is a monetary policy no-no.
Predictably (because it has happened every time I write on this topic) our article generated several comments to the effect that we didn’t know what we were talking about, because banks couldn’t possibly prefer the meager 100 basis points they can earn by holding reserves (or something less than that, if they are obliged to pay FDIC premiums) to the far greater amount they can earn by making loans.
The remarkable thing about these criticisms is that they all appear to deny that banks (or some banks, in any event) are in fact sitting on large amounts of excess reserves, and that they are, to that extent, settling for a return on those reserves of 100 basis points or less, instead of swapping reserves for other assets.
Excess Reserves
Let’s take a step back and look at the definition of “Excess reserves“.
“In banking, excess reserves are bank reserves in excess of a reserve requirement set by a central bank.”
Required Reserves
The reserve requirement (or cash reserve ratio) is a central bank regulation employed by most, but not all, of the world’s central banks, that sets the minimum amount of reserves that must be held by a commercial bank. The minimum reserve is generally determined by the central bank to be no less than a specified percentage of the amount of deposit liabilities the commercial bank owes to its customers.
[in the US] Effective 27 December 1990, a liquidity ratio of zero has applied to CDs and time deposits [e.g. saving accounts], owned by entities other than households, and the Eurocurrency liabilities of depository institutions. Deposits owned by foreign corporations or governments are currently not subject to reserve requirements.
Canada, the UK, New Zealand, Australia, Sweden and Hong Kong have no reserve requirements.
This does not mean that banks can – even in theory – create money without limit. On the contrary, banks are constrained by capital requirements, which are arguably more important than reserve requirements even in countries that have reserve requirements.
Are Banks Slowly Lending Excess Reserves?
One might superficially conclude that banks are lending reserves by looking at the above chart, but here is what’s really happening:
In the process of lending, a portion of the loan gets redeposited in instruments that have reserve requirements.
Thus, my statement “reserves do not change whether a bank lends more or not,” is incorrect even though it takes a long time to matter in a meaningful way.
Everything else I stated is correct because reserves, excess or otherwise, do not enter into bank lending decisions.
BIS Statement
Please consider BIS Working Papers #292 Unconventional monetary policies: an appraisal, page 19.
In fact, the level of reserves hardly figures in banks’ lending decisions. The amount of credit outstanding is determined by banks’ willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans. The aggregate availability of bank reserves does not constrain the expansion directly.
By the same token, an expansion of reserves in excess of any requirement does not give banks more resources to expand lending. It only changes the composition of liquid assets of the banking system. Given the very high substitutability between bank reserves and other government assets held for liquidity purposes, the impact can be marginal at best. This is true in both normal and also in stress conditions. Importantly, excess reserves do not represent idle resources nor should they be viewed as somehow undesired by banks (again, recall that our notion of excess refers to holdings above minimum requirements). When the opportunity cost of excess reserves is zero, either because they are remunerated at the policy rate or the latter reaches the zero lower bound, they simply represent a form of liquid asset for banks.
A striking recent illustration of the tenuous link between excess reserves and bank lending is the experience during the Bank of Japan’s “quantitative easing” policy in 2001-2006. Despite significant expansions in excess reserve balances, and the associated increase in base money, during the zero-interest rate policy, lending in the Japanese banking system did not increase robustly.
Bank Credit vs. Reserves
Between July 2008 and May 2017, bank credit rose by $3.59 trillion. Required reserves rose by all of $134 billion.
Does Rising Interest on Reserves Hurt Lending?
Selgin says the Fed needs to halt paying interest on excess reserves to spur lending. Curiously, bank credit rose over $900 billion as the Fed was hiking.
If there is any slowdown in lending, it is due to the slowing economy or lack of good customers, not that the Fed is paying increasing amounts of money for excess reserves.
Loans and Leases vs Reserves
Selgin used loans and leases in his links, so I provide the above chart as an alternative to bank credit. One can look at M2 to see similar things.
Banks Lend, That’s What They Do!
Bakers bake, painters paint, homebuilders build, and bankers lend. That’s what they do.
If banks are not capital impaired, and they believe they have a good credit risk who wants to borrow, they lend. In the process, required reserves rise by a tiny amount.
But it’s capital impairment and creditworthy customers that drive the lending process, not reserves. The BIS has this correct.
Definition of Demand
Demand has a couple of meanings. In widespread use, demand is an imposition on someone (e.g. pay me or else).
What Selgin refers to as demand is the “desire of banks to hold money”. He cites $2 trillion in excess reserves as “proof” of “demand”. The statement is silly.
Banks did not demand $2 trillion in the classic sense, nor are they hoarding money because the Fed pays interest on reserve. Rather, the Fed crammed over $2 trillion into the system.
If banks had creditworthy customers willing to borrow, banks would lend. It’s what they do, and it is precisely what the charts I presented show.
Slow Elimination of Excess Reserves
Conclusions
- Banks lend if they are not capital impaired and they have customers deemed creditworthy. Reserves do not factor into banks’ willingness to lend.
- Banks are not demanding excess reserves. The Fed forced excess reserves into the system.
- Elimination of interest on excess reserves will not spur lending.
Selgin has things backward. There is not a demand for cash by banks that is holding up lending. Such a condition would occur if banks were capital impaired. Rather, there is a lack of demand for loans, by creditworthy borrowers, at a sufficient pace to quickly eliminate excess reserves.
As an aside, I am in favor of eliminating interest payments. Giving banks free money at taxpayer expense is galling.
Corrections
I added the chart on the slow elimination of excess reserves and corrected a few minor typos.
Mike “Mish” Shedlock
Mish, you are 100% correct. I firmly believe that it is almost incomprehensible to most people, including economists, that in a fractional reserve banking system, banks are creating money out of thin air. Reserve requirements have almost no effect on behavior, especially when the FFR is miniscule.
People think in terms of still being on a gold standard and banks lending deposits.
In terms of the Fed’s balance sheet, I think the Fed did an admirable job of meeting the banks liquidity needs after the meltdown. It kept the system from turning a liquidity crisis into a solvency crisis. However, I also believe that the interest paid on reserves is a bailout for potential solvency issues, and should not be in the Fed’s charter.
Mish,
Recall the advise that Rick gave to the Germans in Casablanca: There are parts of monetary theory where it is unwise to dispute Selgin.
you and Steve Keen are correct. The decision to pay interest on excess reserves is just a sop to the investing banks. It costs the Fed nothing to mark up reserve accounts with numbers representing interest money. Maybe banks just want somewhere safe to send their money and there is no bank safer than the Fed. It could also be a monetary operation to get more money tied up.
“Maybe banks just want somewhere safe to send their money and there is no bank safer than the Fed.”
No, there is no other place for the dollars period. Their only existance is in Fed’s balance sheet. They cannot leave. When you pay Chinese, the dollars still don’t leave Fed’s computer, just the holders change. Even if you demand cash, they are still Fed’s liabilities.
Currencies don’t leave currency zones.
OT.
EU financial corruption reaches a new level of blatancy. Spain and two other countries are using the leverage of denying an agreed bailout to force Greek judicial procedure into exemption of their nationals. The implications are many.
http://www.keeptalkinggreece.com/2017/06/16/spain-block-tranche-greece-eurogroup/
http://internacional.elpais.com/internacional/2017/06/16/actualidad/1497596431_472840.html
Putting aside the corruption problem (which is a BIG problem in and of itself) … it says a lot about the viability of the EU that they have to cheat on their own rules just to survive another day.
Its one thing when one lies to other people (its often a crime), but when one starts lying to one’s self…. that’s when things are about to get a whole lot worse
Yes. Here is another front opening now (and yet another is EU reprimanding eastern European countries over migration stance).
This is @ samij if he is reading :
FT warns populists, using Finland political upheaval as an example, that it does not pay
https://www.ft.com/content/fe376512-51b8-11e7-bfb8-997009366969
But if you read through
http://gatesofvienna.net/2017/06/those-fissiparous-finns/#more-43252
You get a clearer idea of who is lying to themselves and not respecting their own standards.
Mish,
You are 100% correct. Reserves are look excess inventory. Every business would like to sell the inventory they have on hand. The demand for loans (for qualified borrowers) just isn’t enough to adsorb the reserves.
Excellent analysis.
“The demand for loans (for qualified borrowers) just isn’t enough to adsorb the reserves.”
No matter how many loans banks make, the amount of reserves remains the same. That is because banks don’t lend out reserves to the real economy, they cannot. Mish is correct, you are not.
I didn’t really bother reading this post carefully.
When a cloistered “professor” starts babbling about topics anywhere off campus, especially about something out in the real world — their opinions generally aren’t worth anything at all.
Academia really needs to pull their heads out each other’s rear ends. It doesn’t matter what their theories say, if their theories conflict with real life. Real life is correct, academic theory is wrong. End of discussion.
My alma mater just sent their VP of something to ask why my company stopped interviewing students or hiring recent grads (we hired ZERO this year, first time in a long time). These kids are graduating with an indoctrination in radical left wing politics and very little in the way of actual knowledge or critical thinking skills. The cost of deprogramming their cult thinking (and that is exactly what it is — cult thinking) is enormous. And yes, to any professors reading this — it is the faculty’s fault. You are failing at your jobs.
A quick glance at Mish’s summary statement suggests to me he is probably correct in this debate… but even if there are subtleties that Mish overlooked, a professor sitting on campus has far bigger problems that must be addressed before academia’s opinions merit a hearing.
Mish,
Several weeks ago I tried to get a comment put into moderation — so I deliberately included a bunch of unnecessary profanity, figuring that would surely put the comment into moderation… The comment posted immediately, profanity and all.
Then there are comments like the above, which seems rather harmless — and it gets tagged for moderation?
Medex – I tried to email you but your email address is wrong
Email me
That is the account I give to stores for all their “can’t miss” promotions 🙂
Last time I logged in, there were 1000+ unread messages, including one from Marissa Mayer warning me my account might be deleted for inactivity. Maybe she carried out her threat
Will look into it this weekend and email you
The extraordinary amount of excess reserves currently sitting at the Fed serves two purposes.
These are:
1.) Provide a liquidity backstop (insurance against a system-wide “bank-run”, as occurred in 2008). This was especially relevant to the “ZIRP” period, where depositors/creditors were being obviously under-compensated for risk, and their behavior in such a “unique” environment was unpredictable.
2.) Provide a “backdoor” re-capitalization of bank balance sheets through the payment of interest on excess reserves.
Period.
I agree with Mish. Banks do not abstain from lending because they are “reserve constrained”. They can always borrow someone else’s excess reserves (except when there is a system-wide “bank-run”) if needed.
Banks abstain from lending if they are CAPITAL constrained. And loan demand (availability of credit-worthy, willing borrowers) obviously is a major factor as well.
Creating excess reserves and paying interest on them *is* an effective way of redirecting taxpayer money to plug a smoking hole in a balance sheet over time.
Explained here
http://wolfstreet.com/2017/01/11/fed-pays-banks-12-billion-in-taxpayer-money-for-2016-excess-reserves/
Here is an ‘interesting’ article regarding taxpayer and public money. It starts with a good critique of QE, but then goes on to claim that the solution is public spending, us or them style. Two heads of the same monster I think. As long as anyone has monopoly on the creation of money these kinds of misleading arguments will continue to rule over and confuse the world.
http://www.primeeconomics.org/articles/was-375-bn-of-qe-raised-from-taxpayers-is-there-no-such-thing-as-public-money-only-taxpayers-money-as-pm-asserts
QE rubber must hit the road somewhere. Correct this :
Interbank liquidity contraints due to NPL and poor asset allocation led to CB intervention in the form of QE, which guaranteed system wide liquidity. The effect was marginal, where failure of any financial entity was going to occur at the margin. It follows that lending was increased in the form of mainly only supporting the pre-existing set of contracts where failure due to distrust of valuation between banks would have normally led to a decrease in total lending, due to a write down /destruction of existing debt. Summary, reserves created by QE are new lending by the CB itself to banks, they falsely validate an older market that had become misplaced OR they adjusted the construct of the system to bridge its shortcomings.The action was, either way, arbitrary and beyond individual or public accountability.
O/T …. Amazon (in buying Whole Foods) essentially admits they had (and still have?) a major logistics weakness when competing with brick and mortar stores.
Amazon supposedly has an advantage by being online only, not having to pay for retail store space and so forth… but especially when it comes to groceries, they are weak compared to Walmart, Costco, Kroger, Ahold, Publix, etc. And today Bezos admitted Amazon has a big problem because he felt the need to buy Whole Foods at a big 24% premium to where it had been trading.
The profit margin for a typical grocery store is (maybe) around 1-2%. Somebody has to stock the shelves, even if Bezos intends to eliminate cash registers. Somebody has to collect grocery carts and those little carrying boxes that customers use to carry their purchases to their cars. And most important of all… the highest margin food products (by a LONG shot) are prepared foods: salad bars, deli sandwiches, rotisserie chicken, baked goods, etc… things made by people. If the store offers food that was prepared en mass at some other location, then it is not fresh and its the same as the national brand pre-packaged items.
Bezos says he is going to eliminate cash registers (and cashiers), but they aren’t big cost centers. Most grocery stores already have self-pay registers. I am sure Bezos can save a little (vs Whole Foods costs), but its not much. And all the other grocery chains are already implementing the same ideas.
Plus Amazon now has to pay a massive M&A acquisition premium above and beyond the basic cost structures that every grocery chain has.
And the highest profit margin products are still the ones prepared (by humans) locally at each store. Does Bezos have a plan to have robots manning the deli department?
What isn’t being said here today is that excess reserves were created as a byproduct of the attempt to lower long term interest rates.
Correct, you cannot tell what banks do with their reserves by looking at the them. Banks did use their reserves to replace the bonds they sold to the FRB. Thus the banks not only get paid on their excess reserves they also get paid on their bonds. Kinda like a double dip.
Banks normally buy bonds they same way they make loans. They create the money to buy the bonds or make loans just by doing so. This time they acquired replacement bonds like a non-bank would by using funds they already have.
The proceeds from the banks buying replacement bonds went to the Treasury where it was spent into the economy ending up in bank deposits and thus back into reserves.
The demand for replacement bonds was what the FRB was after as it would lower interest rates, especially longer term ones, as the FRB cannot directly affect those.
“Correct, you cannot tell what banks do with their reserves by looking at the them. Banks did use their reserves to replace the bonds they sold to the FRB. Thus the banks not only get paid on their excess reserves they also get paid on their bonds. Kinda like a double dip.”
…
I think this is correct. A few years ago I read an article where a professor said banks could pledge excess reserves as collateral with Federal Reserve to buy treasuries. Commercial banks are sitting on several $trillion in treasuries.
“Banks normally buy bonds they same way they make loans. They create the money to buy the bonds or make loans just by doing so.”
This is not correct, banks can buy treasuries only for Fed’s liabilities (reserves). They can buy private bonds for their own liabilities that they create (deposits). The money to buy governent bonds can only come from government (Fed is functionally departent of the governent).
Banks do not and cannot lend reserves. Ben Bernanke said in congressional testimony years ago that reserve requirements are not needed for lending as the FRB will always provide what ever reserves are needed.
Mr. Constable, this is a common but wrong argument. The Fed conventionally targeted the fed funds rate, so the short-run reserve supply schedule was flat, as you say. But the target depended on inflation and such. If the Fed found banks borrowing so much that inflation rose above target, for example, it would raise the target. The long-run reserve supply schedule was therefore not horizontal, which is the same thing as saying that ultimately bank lending was in fact reserve constrained.
Of course, were the Fed willing to let banks lend all they wanted, despite inflation etc., maintaining a fixed funds rate by hook or by crook, you would be correct. But that isn’t (fortunately) how the Fed or other relatively responsible central banks manage the reserve supply.
“But banks most certainly can get rid of excess reserves by lending them, because as banks acquire new assets, they also create new liabilities, including deposits.”
Banks can get rid of excess reserves by lending them to who? Again, reserves are not lent to the real economy, banks can lend the reserves to each other and that doesn’t reduce the amount of reserves. It is a simmple but common mistake that mainstream economists make. Only the holders of reserves change, not the amount.
At the margin, being able to get a return on Fed deposits, inevitably do figure into lending decisions. Imagine the effect on lending, if the Fed paid a million percent a millisecond interest on reserve balances…..
Stuffing the system full of excess reserves, may have been partially done to give the Fed an additional lever of discretionary control over loan volumes. In addition to the obvious “benefit” of allowing the Fed to recapitalize banks to the tune of tens of billions, entirely at their discretion. IOW; the vastly increased volume of reserves, give the Fed even greater control over what many like to pretend is some sort of a free market.
Banks desperately closed their books daily at the end of the day to see if they have enough “funding”. That is, to see if they have enough cash to pay off the many short term loans that matured that day. If they don’t have enough they borrow it over night from other banks that have excess cash.
This inter-bank lending dried up after QE because the banks had so much excess reserves they could meet their funding requirements. This is liquidity. Liquidity was also a goal of the FRB in doing QE.
Many argue and it has been argued here that QE is the cause of the stellar rise of the stock market; that QE was money printing and the money went into the stock market. No, not true.
There are several obvious reason the stock market rallied so much. Low interest rates. Stock buybacks. TINA-there is no alternative. The stock market may have rallied anyway as does happen after a recession. Psychology-believing that QE created reserves go into the stock market. Not wanting to miss out on the bull market.
Yes, but QE in large part created low rates, those provided margin for stock buy backs, stock valuation to increase… anything with a higher return. The psychological part is the investment into a rising market based simply on its rising value, as the price of money was decreasing due to lower interest, all other assets will have experienced this to some degree, some losing less, others gaining more. Basically a fix, but not as even (or at all even) as would first seem.
You are absolutely correct, demand drives loans, not “reserves.” This is yet another example of the Fed believing in its own omnipotence, when year after year the facts prove how ineffectual it is. How can they fix the problem when they don’t even know what the problem is?
“The remarkable thing about these criticisms is that they all appear to deny that banks (or some banks, in any event) are in fact sitting on large amounts of excess reserves, and that they are, to that extent, settling for a return on those reserves of 100 basis points or less, instead of swapping reserves for other assets.”
…
So? … you are ignoring the growth of the shadow banking sector:
“According to the Financial Stability Board, the august body that makes recommendations to the global financial system from Basel, Switzerland, “other financial intermediaries” — the category that includes non-bank lenders but not insurance companies and pension funds — increased their assets to $80 trillion, or 23 percent of total financial assets, in 2014. Their average growth reached 5.6 percent in 2011 through 2014, while the global banking system’s assets stopped growing during that time.”
https://www.bloomberg.com/view/articles/2017-03-28/shadow-banking-is-getting-bigger-without-getting-better
And, you are ignoring the stricter lending standards for commercial banks. As a small business owner I regularly have to deal with banks. In the past you could get a loan pledging an asset as collateral to get loan. Now? They wanted me to sign personal guarantee for full amount. Screw that.
Mish, is spot on. Lack of demand.
Also, do not forget surge of lease / rent to own financing which is technically not debt.
“Giving banks free money at taxpayer expense is galling.”
Especially when no banker has been prosecuted for the greatest financial crime in the history of the country.
Bankers have been placed above the law.
Macro: Correct me if I am wrong. (I’m a student of these things, not an expert). Reserves (required and excess) deposited with the Fed are not redeposited by the fed with another bank. Those reserves merely turn into entries on the Fed’s balance sheet. The Fed does not make one bank’s reserves available for another bank to lend.
Micro: A bank uses money to generate earnings. At any given time, a bank’s money can be occupied in various ways. For example, some of a bank’s available money might be paper-currency reserve deposited in the bank’s vault, Some might be funds deposited as reserve with the Fed. And some is on loan to the most credit-worthy of the customers who wish to borrow from the bank.
Now, consider each individual bank’s decision to deposit some of its funds with the Fed as excess reserves.The bank will distribute its money among the several available uses in the manner it believes will generate the most earnings. Each available use competes, within the bank, with all the other available uses. Paper-currency reserves in the vault competes with reserves deposited with the Fed. Reserves deposited with the Fed compete with loans to customers.
Receiving interest on money deposited as reserve with the Fed makes that use of money more profitable and more attractive than not receiving interest on it. When the Fed started paying interest on reserve deposits, and each time it has increased the interest rate, it increased the profitability and attractiveness of that use of a bank’s available money. Banks will tend to move some portion of the money from their vaults (where it earns nothing) into the Fed. Likewise, depositing money with the Fed becomes more attractive than loaning that money to some portion of the bank’s most marginal customers,
From the perspective of certain marginal customers, the customers who would have gotten loans had the Fed not been paying interest on reserves, for those customers the Fed paying interest on reserves has made the funds unavailable.
The FED and Big Bank relationship reminds me of an Escher drawing. Up and down are one and the same thing. Smoke and mirrors with mumbo jumbo lingo and viola the poor hapless Banks end up with a riskless 22 billion per year granted by the very entity they are intrinsically part of. I hear two year guarantees are back in Bank space. Loverly!
Those who can do, those who can’t are professors
Well Professors know how to steal too…..
The Fed pays interest on ALL reserves. So from the banking system point of view IOER is a non-factor since if a loan is made and “excess” reserves are reclassified as “required” the banks still get paid interest on them.
The same rate (now 1.25% after the most recent meeting) is paid on both as can be see here: https://www.federalreserve.gov/monetarypolicy/reqresbalances.htm
Commercial banks own the Federal Reserve via preferred shares. Payout?
6%
https://www.federalreserve.gov/aboutthefed/section7.htm
Commercial banks own each of the 12 Federal Reserve BANKS, Incorporated (each with a BG of nine directors,sometimes identified as a franchise for which they are required to purchase non-transferable shares; i.e., they buy the right to clear checks, etc.) which are under the administrative and regulatory control of the Federal Reserve BOARD OF GOVERNORS. Who owns the Board of Governors ?
Normally the FRB adjusts reserves to influence interest rates. They cannot do that now as reserves are too large. Interest paid on reserves is a way to push up short term interest rates.
However, this has not translated into pushing up longer term interest rates as the FRB wants.
Here is that mumbo jumbo again, we just have to pay on reserves since its the only way to increase rates! The hapless Banks just have to accept the windfall! How about keeping rates where they are and reducing the FED balance sheet. Rates will naturally raise with balance sheet reductions. Mind you rates will only be impacted with very significant balance sheet reductions, read John Hussman. Directly raising short term rates is absolutely the last thing to do given the horrible state of the economy.
Reblogged this on John Barleycorn and commented:
More corruption
If banks can make more from interest on Reserves than they can from the interest they get on loans then they would naturally choose to stop lending and collect interest from the Federal Reserve.
Wrong Michael
Not the way it works
Loans reduce excess reserves by a trivial amount – not necessarily at the lender who made the loan, but the system itself
The loans don’t reduce excess reserves not even by a trival amount. What happens when banks make a loan? They just credit your bank account without even touching the reserves, they change numbers in your account. If the created deposit goes to another commmercial bank then the bank that created the deposit has to transfer corresponding amount in reserves to the bank the deposit ended up in. This changed the holders of the reserves, not the amount of reserves. Systemwide the amount of reserves remains the same no matter how many loans are made because banks don’t lend reserves to the real economy. Me and you don’t have those reserve accounts at Fed, only financial institutions do. The only operations that reduce/increase reserves are done by the governent and fed. When governent/fed sells/buys treasuries, taxes economy, spends, lends. Fiat is government’s monopoly.
Eliminating interest on excess reserves and banks will simply do what they always did: buy treasury bills in place of the excess reserves. Interest on treasury bills is in effect EXACTLY the same thing as paying interest on excess reserves. The difference is an irrelevant technicality.
And, pray tell, what happens to the reserve balances that are gotten rid of to pay for the Treasury bills when another bank gets hold of them, as must inevitably happen? Why, it does the same thing. And then another does it, and so on, hot-potato fashion, until deposits expand to the point were the potato has cooled down (all reserves required). Well, the point is, that it makes a vast difference to total deposit creation whether banks want to retain excess reserves or not. Or so it seems to some of us foolish and useless academics!
That is monetarist bs, bank lending is not reserve constrained. economicsjunkie is correct.
Precisely, bank lending is constrained by the availability of willing and able borrowers. Banks can and will obtain the reserves weeks later if needed and via overdraft at the fed worst case scenario, at any point in time. No loan officer sits at a bank waiting for enough reserves to come in so they can lend. They often don’t even know what the point of reserves is! lol
They don’t have to end up with other private banks. They are literally drained from the banking system if the fed sells them to the private banks to keep short term rates within the policy rate window. Currently excess reserves are very similar to short term treasury bills, so to banks there’s no reason to look for competitive offers from the fed for a certain portion of their excess reserves.
Mike, some of your remarks make me wonder whether you have misunderstood my argument. I said that banks _usually_ exchange their excess reserves for other interest-earning assets, and in the long run mainly for loans–and that is indeed what happened until October 2008, as your own chart shows. There was never any significant accumulation of excess reserves until October 2008; yet there certainly were cases of substantial Fed reserve creation before that date. I argue that banks have _not_ been doing this since October 2008, owing to the influence of positive IOER. Your chart shows that as well. So I’m not sure what it’s point is.
Pre-2008 experience shows, in any case, that the Fed never could “cram” excess reserves on banks. It can cram “reserves” on them, but it cannot force banks to hold reserves in excess of their minimal legal and clearing and settlement requirements instead of trading them for other assets, as banks effectively do when they either buy securities or make loans (the proceeds of which are spent, adding to the lending banks’ net settlement losses, other things equal). By doing these things banks do expand system deposits, and do expand system required reserves, other things equal. Of course, the bigger the increase in R, the bigger the proportional increase in D required to eliminate excess reserves.
After 2008, it would have taken massive growth to do this. No one–certainly not I–believes that the Fed would have tolerated such an outcome. But then again, the Fed instituted IOER for precisely the purpose of allowing R to increase (at first in connection with its post-Lehman emergency lending programs, then owwing to its LSAPs) dramatically without any proportional increase in commercial bank deposits. Bernanke and other Fed officials are quite clear on this having been their intention. (Yes, I know: they may also be confused. Well, I think they are on many things, but that in this case they knew what they were about.)
As for banks holding reserves not because they demand them, but because they lack good lending opportunities, it is a false dichotomy: both things are relevant to the story. Nor have i ever meant to suggest otherwise. (Indeed, I have drawn attention to the role of limited lending opportunities more than once.) Were loan demand stronger, the modest return on excess reserves would not have sufficed to create as great a demand for excess reserves as we’ve witnessed. It is the relation between the demand for loans, and hence the return that loans of any given quality offer, and the rate offered on reserves, as well as rates on securities, that determines the excess reserve: deposit ratio. In a different environment, 100 basis points wouldn’t be enough to matter. In this one, it is enough! (Some banks used to hold T-bills as secondary reserves. Well, those have been yielding less than reserves. What’s a good money manager to do?) Talk to people at the big banks that are actually holding the excess reserves–these are not community bankers!–and they’ll tell you how they have deliberately accumulated excess reserves, because it pays more than buying securities or lending! Heck, some have been acquiring reserves by repo-ing T-bills, and profiting on the difference.
I must say, finally, that I find it quite surprising that you and so many other persons presumably acquainted with basic economics are so quick to insist that the usual law of demand doesn’t apply to the particular asset category “excess reserves” (which should really be understood, by the way, to mean reserves above those needed for clearings and settlement in the case where there are no minimum legal reserve requirements), as you do in effect by insisting that raising the relative return on excess reserves has no bearing on the quantity of excess reserves demanded. In fact, in a graph of mine that you don’t reproduce here, I show a very strong relationship between banks’ deposit/excess reserve ratio and the relative return on reserves relative to the LIBOR (a comparable short-term rate). I would be interested in your attempt to reconcile that close correlation with your reserve “cramming” hypothesis.
“Mike, some of your remarks make me wonder whether you have misunderstood my argument. I said that banks _usually_ exchange their excess reserves for other interest-earning assets, and in the long run mainly for loans–and that is indeed what happened until October 2008”
Reserves cannot be exchanged for loans, reserve balances are only used to settle payments in between banks and goverrnent (some foreign banks and governments might have access also). Banks create deposits(make loans) without touching the reserves, reserves cannot be lent to the real economy. Your argument is incorrect.
Exactly, reserves are in effect only needed in the following scenarios:
1. A bank clears a check from another bank
2. Someone pays his taxes to the government via bank check/transfer
3. Someone makes a cash withdrawal at an ATM or teller
For example, the Canadian central bank has a ZERO reserve requirement, but banks will keep them for the above events or enter into an overdraft with the central bank and then obtain them later.
Kristjan: “Banks create deposits(make loans) without touching the reserves, reserves cannot be lent to the real economy. Your argument is incorrect.” economicsjunkie: “xactly, reserves are in effect only needed in the following scenarios:
1. A bank clears a check from another bank.”
I see. So, suppose a bank makes a loan. The borrower spends the proceeds. A check for them lands at another bank. The check is cleared. The first bank’s reserves are “used” to settle with the second. Thus reserves are ‘touched” precisely to the extent of the loan, other things equal. On the first bank’s balance sheet, cash goes down, loans go up. In that sense, it is in fact reserves that have been “lent.”
This is basic monetary economics. I understand, from long experience, that many people, bankers among them, don’t “get” it. In fact they’ve made a silly mantra out of “banks don’t lend reserves.” But every banker on the planet may shout it from the rooftops for all I care: they’ll still be wrong.
“The first bank’s reserves are “used” to settle with the second. Thus reserves are ‘touched” precisely to the extent of the loan, other things equal.”
This is when deposit moves to another bank, this can happen without a loan. Making loans leaves reserves “untouched”. Your argument was that reserves “get used up” when banks exchange them for loans. That is incorrect. Banks use reserves for payment settlement, not to make loans. Even the borrowing reseve balances from each other leaves the amount of reserves “untouched”. Bank lending is not reserve constrained.
No, those reserves are not “lent” in that scenario. Lending reserves literally refers to activity on the interbank lending market or lending from the Fed to private banks directly. Reserves are the banks’ money. They are recorded in the banks’ “checking accounts” at the Fed (called bank reserves). They only circulate among banks. But reserves are NOT extended to bank borrowers. The borrower only sees a checking account markup and the same goes for everyone in whose name he writes a check.
George Selgin is talking about deposits leaving the bank that made the loan. There might be many reasons why a bank is having hard time of keeping happy depositors or getting deposits, banks making loans is not one of the reasons.
Yes, that’s why they often offer savings accounts & CDs, which facilitate clearing in their direction rather than away from them.
“As for banks holding reserves not because they demand them, but because they lack good lending opportunities, it is a false dichotomy:”
…
Really?
IOER was 25 bps until 2016. Are you seriously going to argue that enough to deter lending?
https://fred.stlouisfed.org/series/IOER
In 2009 FASB 157 moved from mark to market to mark to model on assets held … still in place. Why? More likely banks still capital impaired and IOER back door bailout for Wall Street banks.
Emergence of shadow banking + stricter lending standards for commercial banks = lack of demand for traditional bank lenders.
Yes, I am perfectly serious. Those 25 basis points were higher than returns on other low-risk short turn assets, including repos and most T-bills, and LIBOR. Go ahead and plug those into your FRED diagram and see for yourself! As I said, what matters, as I said, is not the absolute level of IOER bit were it stands relative to other rates. “Lack of demand for loans” is just one factor informing the low level of those other rates. To suggest that slack demand informed hoarding of reserves but IOER rate doesn’t is about as silly as claiming that one side of a pair of scissors is the only one doing any cutting!
Finally, banks were only capita impaired for a time in 2009; not since; yet the accumulation of excess reserves continues. I’ve got the data to show that, too.
Yep banks were capital impaired only for a short while thanks to revised mark-to-market rules.
Lending now thus is dependent on one and only one thing: creditworthy borrowers being willing to borrow.
The BIS has this correct. You are flat out wrong. Reserves or interest on reserves plays no role in willingness to lend. Why is this so hard to grasp?
Lending takes excess reserves down little depending on the how the loan money is redeposited (and might not that be elsewhere?) Why not make a loan, make money on it (and keep nearly all of the excess reserves and make money on that too?)
In practice, reserves do not play into lending decisions.
Bangor Business School Working Paper
Did Negative Interest Rates Impact Bank Lending?
“The coefficient on NIRP is sizeable, negative and statistically significant at the 1% level, indicating that countries in which central banks implemented NIRP experienced a decline in total bank lending of around 7.4% relative to those countries in which central banks did not follow this policy.”
https://www.bangor.ac.uk/business/research/documents/BBSWP-17-02.pdf
So much for the hot potato 🙂
But the monetarists keep repeating their false theories. Science progresses one funeral at a time…….