Frances Coppola — Banks Don't Lend Out Reserves

Frances sets the record straight.

Banks cannot and do not “lend out” reserves – or deposits, for that matter. And excess reserves cannot and do not “crowd out” lending. We are not “paying banks not to lend”. Positive interest on excess reserves exists because the banking system is forced to hold those reserves and pay the insurance fee for the associated deposits. It seems only reasonable that it should be paid to do so.

Forbes

Banks Don't Lend Out Reserves

Frances Coppola

Frances also writes:

The volume of excess reserves in the system is what it is, and banks cannot reduce it by lending. They could reduce excess reserves by converting them to physical cash, but that would simply exchange one safe asset (reserves) for another (cash). It would make no difference whatsoever to their ability to lend. Only the Fed can reduce the amount of base money (cash + reserves) in circulation. While it continues to buy assets from private sector investors, excess reserves will continue to increase and the gap between loans and deposits will continue to widen.

This can to be broken out further. Reserves comprise of reserve balances that depository institutions hold at the central bank and banks' vault cash, and currency in circulation. Bank reserve balances, bank vault cash, and currency in circulation comprise the monetary base.

Those without access to the central bank must get currency through those that do. Banks exchange reserve balances held at the central bank for vault cash and disperse it on demand through the window.

Reserve balances originate in either government spending or lending. Central banks lends only to institutions with an account at the central bank. Reserve balances are created through government spending in accordance with appropriations. Agencies spend and the Treasury settles accounts by directing the central bank to credit bank reserve balances, based on which banks credit the relevant customer accounts.

Note that "reserves" include only 1) bank reserve balances held at the central bank by non-government institutions and 2) bank vault cash, and and 1) plus 2) plus 3) currency in circulation. This is the monetary base.

When a central bank is not paying interest on reserve balances and wishes to set the overnight rate about zero, then it must manage the amount of bank reserves held at the central bank as excess reserves to hit its target rate in the interbank market. Too little. and the rate will be driven above the target rate; too much, and the rate will be driven below the target rate. The central bank uses OMO (open market operations) to manage the level of excess reserve balances, increasing reserve balances by buying Treasury securities from primary dealers and decreasing reserve balances by selling Treasury securities to primary dealers

Reserves (reserve balances and cash) are withdrawn from non-government by payments to government that involve a decrease in aggregate non-government holdings of net financial assets, e.g,, taxes, fines and fees. When the central bank lends or purchases government securities, non-government holding of net financial assets remains unchanged; only the composition change but not the amount. However, when taxes, fees and fines are credited to the Treasury non-government holding of net financial assets in aggregate decrease.

When taxes are paid to a Treasury TT&L (Treasury tax and loan) account at a commercial bank, the funds are withdrawn from non-government use, but not the reserve balance, which remain with the bank, since a Treasury deposit account has been credited at the bank. That is to say, the monetary base does not change at this point, even though the obligation to government has been satisfied. Although the funds are no longer available to non-government, the reserve balances remain on the banks' books and at the central bank.

Reserve balances do not decrease at the bank until the TT&L account is drawn down when the Treasury directs the central bank to credit funds from a TT&L account to the TGA (Treasury General Account) at the central bank. Debiting a TT&L account and crediting the TGA with bank reserves held in the TT&L withdraws reserves from non-government decreasing non-government net financial assets in aggregate, instead of just making the funds unavailable. This affects the monetary base, whereas the reserve balances in a TT&L account still count toward the bank's reserve balances, hence, toward the monetary base.

The Treasury and central banks use TT&L to help the central bank to manage the interbank market  through adjusting banks' reserve balances when it chooses to set the interest rate above zero and is not paying interest on reserve balances.