Why Are Banks Holding So Many Excess Reserves?

Abstract

The quantity of reserves in the U.S. banking system has risen dramatically since September 2008. Some commentators have expressed concern that this pattern indicates that the Federal Reserve's liquidity facilities have been ineffective in promoting the flow of credit to firms and households. Others have argued that the high level of reserves will be inflationary. We explain, through a series of examples, why banks are currently holding so many reserves. The examples show how the quantity of bank reserves is determined by the size of the Federal Reserve's policy initiatives and in no way reflects the initiatives' effects on bank lending. We also argue that a large increase in bank reserves need not be inflationary, because the payment of interest on reserves allows the Federal Reserve to adjust short-term interest rates independently of the level of reserves.

Unconventional Monetary Policies: An Appraisal

“… 31 And, of course, just as the private sector on its own cannot get rid of government paper, the amount of reserves in the banking system will remain the same regardless of the volume of new loans generated, absent a deliberate decision by the central bank to reduce it. Keister and McAndrews (2009) discuss these issues in the US context. …”

The Financial Impact of Lender‐of‐last‐resort Borrowing From the Federal Reserve During the Financial Crisis

“…Otherwise the lending would lead to a lowering of the effective federal funds rate relative to target. See Keister and McAndrews () for support for the fact that Fed lending was generally offset by open market operations.…”

Self‐Fulfilling Liquidity Dry‐Ups

“…Since August 2007, U.K. banks have substantially increased their liquidity buffers (Acharya and Merrouche ()); since September 2008, there has been a dramatic increase in the excess reserves of European banks (Heider, Hoerova, and Holthausen (), Pisani‐Ferry and Wolff ()), and of U.S. major deposit institutions. Keister and McAndrews (), however, point out that a substantial part of the increase could be due to factors other than hoarding.…”