Why Are Banks Holding So Many Excess Reserves?

That’s the question posed by a recent staff report from Todd Keister and James McAndrews at the New York Federal Reserve.

Their answer? Because the Federal Reserve has been really, really busy.

Keister and McAndrews begin their analysis by documenting the remarkable increase in excess reserves since the fall of Lehman:

Since September 2008, the quantity of reserves in the U.S. banking system has grown dramatically, as shown in Figure 1. Prior to the onset of the financial crisis, required reserves were about $40 billion and excess reserves were roughly $1.5 billion. Excess reserves spiked to around $9 billion in August 2007, but then quickly returned to pre-crisis levels and remained there until the middle of September 2008. Following the collapse of Lehman Brothers, however, total reserves began to grow rapidly, climbing above $900 billion by January 2009. As the figure shows, almost all of the increase was in excess reserves. While required reserves rose from $44 billion to $60 billion over this period, this change was dwarfed by the large and unprecedented rise in excess reserves.

Some observers have expressed two concerns about the spike in excess reserves:

• First, some have wondered whether the spike in excess reserves means that banks are refusing to lend. Keister and McAndrews, however, are skeptical of that concern, arguing that “the quantity of excess reserves … reflects the size of the Federal Reserve’s policy initiatives, but says little or nothing about their effects on bank lending or the economy more broadly.” In short, the excess reserves reflect Fed actions, not bank lending decisions.

• Second, some have expressed concern that the excess reserves are fuel for future inflation (a topic I’ve been meaning to address for some time, but I keep getting distracted by health care). The authors argue, quite rightly in my view, that this concern is also misplaced. The key reason is that the Federal Reserve gained a new power last fall — the ability to pay interest on reserves. That ability breaks the traditional link (in U.S. monetary policy) between reserves, bank lending, and inflationary pressures.

The whole paper is well worth a read for its simple walk-through of how various Fed actions may affect bank balance sheets, reserves, and inflationary pressures.

Comments

[Angry Banker:]

Banks are increasing reserves for several reasons.

1) The Fed has always wanted them to do so, but was not powerful enough to force them. Now, given the banks weak position vis-a-vis the regulators, the Fed now has the ability to twist their arms to make them increase reserves

2) Big reserves make for nice cushions when the economy starts to pick up and defaults go down, but the bank is still having a tough time getting back to normal earnings. Banks will be able to release some of these reserves later to boost profits.

3) With the other accounting gimmicks the banks are utilizing to boost profits in Q1 and Q2 this year, they have room to increase reserves without anyone noticing too much. In other words, it's easy to increase reserves when expectations for your profits are so low. If you actually have some extra profits coming, then its a good time to build reserves as a cushion for the future.

4) Losses from credit cards over the next 12 months are still not clear. Banks are legitimately worried and want to have enough reserves on the books now to cover these losses if the economy doesn't recover as quickly as expected.

5) More reserves means a better balance sheet and thus easier to obtain capital funding from non-governmental sources.

Jul 29 08:18 AM

[White Shield:]

Why do we have "bubbles"? They are created by the Fed and their band of "robber-barons" who buy up on the cheap after they burst.

Banks are the current "bubble in the making" - END THE FED!
Support HR 1207 & S604 for starters...

Jul 29 10:11 AM

[sarge 907:]

Spoken like a true banker, Angry Banker. Better said as: we're not afraid to lend into a failing economy, we just feel better stuffing our coffers with free government (taxpayer) money.

Jul 29 10:42 AM

[john s. gordon:]

excess reserves enable megabanks to buy up other weaker banks & expand their empire.
> jack

Jul 29 10:44 AM

[Dr. O:]

1) Hoard money, pay 0.25% on deposits, and buy Treasurys yielding 4%. Ka-Ching.

2) You know the crap on or off your balance sheets, that's bound to go bad, so you better hold reserves against it.

Jul 29 02:57 PM

[Evan Williams:]

I'm thinking these reserves have something to do with the $600 TRILLION of derivatives floating around in the marketplace, much of which are held by 5 financial firms that are on shaky ground.

Check out ZeroHedge for the full details:
www.zerohedge.com/arti...

I think that banks know it's only a matter of time before many (most?) these derivatives are shown to be worthless--just like AIG's insurance, then the $1 trillion in "excess reserves" they've hoarded will simply vaporize in the ensuing fire.

I think that banks know we've only clipped the tip of the iceberg as far as this financial "crisis" is concerned. Now it's time to watch the Titanic slowly sink.

Jul 29 03:24 PM

[White Shield:]

And for the "negative votes" on my comment - they obviously have not been tracking this:
www2.fdic.gov/hsob/HSO...

Look at the number of failures and "assist" (lack of) over the past 20 years. Look what happened in the early 30's.

Now look at the raping going on by the FDIC with their new rate chart:
www.fdic.gov/deposit/i...

What you are witnessing is the old "give the chicken food on a string - then yank it out" trick. The Federal Reserve is playing the "win-win" while screwing EVERYONE involved.

"Fool me twice, shame on me..."

Jul 29 03:54 PM

[Fighting Yoda:]

Excess reserves get created simply by banks not lending – either banks can lend out the money to borrowers or deposit it with Fed and get some interest (Fed has started paying interest on reserves only recently with rule changes – to help banks earn money). Banks are not finding lending opportunities (unwilling and whatever) so instead are depositing it with Fed. Credit crunch is all about lack of lending and nothing to do with lack of money – Fed is pumping money with helicopters and all other means.

If the economy picks up and banks find suitable lending opportunities – they have to the money to do so – can’t draw and conclusions about future inflation/deflation on this basis. But lack of lending does contract economy and typically leads to deflation.

Jul 29 05:08 PM

[437339:]

Evan

I also read the article on " zerohedge.com " today . Sadly it is both true + UGLY . The mortgage resets coming over next 2-3 years + the commercial real estate implosion is going to take the banks down . NO doubt about this !

Jul 29 09:45 PM

[Susan Weerts:]

Even though Fed claimed that "the excess reserves reflect Fed actions, not bank lending decisions", it was reported several days ago that bank loans remained all time low. We also see increased speculative trades by banks.

Jul 29 11:07 PM

[Gary A:]

I partly agree. Excess reserves will help hold inflation down. But this will cause a chance at a deflationary spiral. While it will make low end RE and China happy, there will be little growth for years. We are Japan. rid-of-debt.com/deflat...

Jul 29 11:53 PM

[Moon Kil Woong:]

Goldman doesn't use excess reserves. It dumps all its money into its program trading division and the rest goes safely out into executives hands via bonuses. Considering this as the alternative, I guess I should like banks holding more reserves.

Jul 30 08:32 AM

[robertsgt40:]

Banks are increasing their reserves for one reason: Greed. They were supposed to grease the economic wheels with the "bailout" money that was stolen from the taxpayer against our will. With incresaed reserves, the banks can strangle what's left of the economy and then come back and buy remaining capitol(what's left) for a song. Simple watson if you understand the origins of central fractional reserve banking. It's criminal by any measure. Abolish the Fed!


On Jul 29 08:18 AM Angry Banker wrote:

> Banks are increasing reserves for several reasons.
>
> 1) The Fed has always wanted them to do so, but was not powerful
> enough to force them. Now, given the banks weak position vis-a-vis
> the regulators, the Fed now has the ability to twist their arms to
> make them increase reserves
>
> 2) Big reserves make for nice cushions when the economy starts to
> pick up and defaults go down, but the bank is still having a tough
> time getting back to normal earnings. Banks will be able to release
> some of these reserves later to boost profits.
>
> 3) With the other accounting gimmicks the banks are utilizing to
> boost profits in Q1 and Q2 this year, they have room to increase
> reserves without anyone noticing too much. In other words, it's easy
> to increase reserves when expectations for your profits are so low.
> If you actually have some extra profits coming, then its a good time
> to build reserves as a cushion for the future.
>
> 4) Losses from credit cards over the next 12 months are still not
> clear. Banks are legitimately worried and want to have enough reserves
> on the books now to cover these losses if the economy doesn't recover
> as quickly as expected.
>
> 5) More reserves means a better balance sheet and thus easier to
> obtain capital funding from non-governmental sources.

Jul 30 09:00 AM

[Billy Ford:]

I am with Jerry on this...Banks dont want to lend because eventhough everyone is forcing recovery down our throats..it isnt happening anytime soon..Nobody is really talking about commercial real estate, but just like residential, the values are through the floor and their notes will be coming due real quick...it will be interesting to see what happens, and I bet the banks are expecting another sh&$ storm

Jul 30 09:04 AM

[Ray Winter:]

Clearly it is not in the Banks interests to hoard money, they really need to make it work for them. Therefore they are hoarding it because they know a major problem is about to rear its ugly head. Virtually 20% of recently completed major construction projects are about to default. Office towers cannot be let, existing tenants are shedding employees and looking for smaller, lower cost space, property developers cannot roll-over their existing loans. The situation is going to get a lot worse.
The banks will be left to pick-up the tab and they probably need a trillion dollars to do so. Q1 2010 will be a key time.

Jul 30 10:49 AM

[stonebluff:]

I spent years as bank counsel and a director of banks. I see nothing sinister in the increase in reserves, which are mostly deposits by member banks of the federal reserve system at the Fed. There is no "excess" of reserves; the reference is to reserves above the amounts required by Fed regulation.. The Fed does have the power to raise and lower reserve requirements; raising reserve requirements takes lendable funds out of the system, lowering them makes more funds available. I don't know what the current required reserve level is, but it's not high. The whole country wants the banks to lend that money when a decent credit shows up.Maintaining reserves above the reserve requirements reflects partly the fact that the Fed now pays interest on reserves, as several people have noted above, but mostly the fear in the hearts of bankers-fear that any new loans they might make will go bad, and fear of unseen and perhaps unseeable losses in all types of current credit. The poor devils are displaying
that prudence that many of them have not shown in recent times.

Jul 30 06:56 PM

[dlaw:]

Great article, thanks.

Jul 31 05:41 PM

[TSteelman:]

Translate this into economic contraction from pre-crash "juiced up" levels. Is the economy 5%, 10%, or 20% smaller once the "juice" is taken out?

Aug 01 10:40 AM

[wongcy:]

In the staff paper, Bank A is keeping the money repaid by Bank B instead of lending it out. Bank B is now borrowing from the Fed instead of Bank A. Conclusion: Bank A is NOT lending! OK, in terms of effect, Bank B as a result does not suffer from credit crunch, but the extra money is simply keeping Bank B alive, not being used to finance other projects. No inflation if money is not being lent out, yes, but is that the objective of Fed's actions?

Aug 04 06:26 AM