Banks do not lend reserves

Me, at Forbes. No, banks don't lend out reserves. They don't lend out deposits, either. And excess reserves due to QE don't "crowd out lending". We are not "paying banks not to lend".

With sincere thanks to Sober Look, whose work I love. Sadly he did get this one wrong. But he's certainly not the only one.


  1. Just a small note, maybe pedantic, but the use the phrase ”out of thin air” is not a good choice if one is explaining how the banking system works. I say that because it brings deposits to the foreground of the discussion , and suggests that a deposit is something prime and fundamental that needs to be created before all else , when in fact the prime mover - the fundamental entity of value - of the credit system is in fact the bond and these are created by the customers. It is the bond that the system is based on , not the deposit. And that is contrary to the uninformed view and the hurdle that the student must overcome.

  2. There's some aspect of the theory of endogenous money that confuses me.
    Suppose bank A creates a new loan for client A. The bank then creates the balancing deposit for client A. Then Client A buys a house or whatever and transfers the required amount to bank B, where the seller of the house has an account. Then reserves that bank A holds at the central bank move to Bank B's account at the central bank. If bank A doesn't have the necessary reserves, it's account at the central bank goes "in red", and then it borrows the required reserves from another bank. So far so good.
    But suppose that the seller of the house also has an account at bank A. Then reserves don't matter. After all, it's not like bank A would have a debt to itself. And now suppose there's only one big bank, so when people transfer money to each other, reserves have no importance .
    See also this lecture by Aidar Turner:

    quote: "Second, in a brilliant insight Wicksell considers what would occur if the banking system
    were organised as “one Bank”. The answer, in a system where all payments were giro payments, is that there would be no freely arising incentive to hold money reserves at all, since all payments out of one customer’s account in the “one Bank”, would have to show up as deposits of another customer in the same bank." (page 3-4)

    In the current system governments/central banks still have some form of control over the money supply because they set the price of reserves. But when there is only one bank (or when customers transfer their deposits to other customers who have an account at the same bank), reserves don't matter, so there seems to be no limit to money creation. Or do I miss something here?

  3. You are correct if a Bank was very large and all transactions were amongst its customers then it would not be controlled by The Bank of England's interest rate policies via it's inter bank reserve policies. For example if one bank served the enirety of the Isle of White then it would not be using reserves, and not be effected the way the Central Bank influences interest rates via reserves.
    However the relevant Bankng regulations would still apply and it would still be paying interest on deposits at probably near the market rate.That is my view I don't know what Frances thinks, see the reference to this situation here

  4. Do you see Peter Stella's "deadwood" analysis of excess reserves as a crowding out argument and, if so, can I take it that you think Stella is wrong on this point?

    1. Yes, I did see Peter Stella's "dead wood" analysis. Try as I might, I can't follow his argument. Reserves carry no capital requirement, so it's not as if they are tying up capital. And they form part of the liquidity buffer, so again, what is the regulatory cost? We don't (yet) have arbitrary limits on bank asset expansion - if we had those, then there would be a crowding-out effect. And as new deposits are created when loans are made, we don't have a problem with asset/liability mismatches. Nor, since banks can still borrow reserves, do we really have a funding problem. I can't see how or why the presence of excess reserves would inhibit lending as he suggests. Yes, velocity of reserves has slowed to a snail's pace, but that shouldn't be a brake on lending. My guess would be that he is mistaking the effect of depressed interest rates for the effect of excess reserves. In my view depressed policy rates do inhibit lending.

  5. Hi All. The point is not about the capital ratio but the leverage ratio.
    The regulatory leverage ratio is capital/(total assets). This is a minimum of 3 percent and for large (highly systemic) will probably wind up in the US at 5 percent a few years from now. The entire point of the leverage ratio is a backstop for capital/(total risk weighted assets). It is crude but meant to be. That means that all assets have the same weight in the calculation. This makes no sense for deposits at the central bank but that is the way the ratio is written. See the recent BIS paper setting out the calculation. There is no exemption for bank reserves (although they are allowing some netting for gross derivative exposures. This is dumb but it is the rule, the only explanation I can give is that when people developed the liquidiy ratio in the US (predates the crisis) bank reserves were so small ($20 billion) they did not bother with thinking about an exception. But now it is a different story. They are in the trillions and the banks cannot dispose of them. So no problem with reserves and the capital ratio but yes a potential problem with the leverage ratio and crowding out. p.s. my last boss is the current head of the BIS and my preceding boss is the current head of the Basle Committee....I am not confused :) but thanks for reading....

    1. Hi,
      You are putting forward the idea that banks are not inclined to trade their newly aquired low risk reserves for actual investments. But this is not going to "crowd out" as you say, because in the alternative scenario the Central bank is not exchanging assets for reserves, and the banks are left with assets that are not used for new lending anyway.

    2. Hi Peter,

      Ah yes. Reserves would affect the leverage ratio, and we are moving in that direction. The inclusion of reserves is an unnecessary distortion, I think. I am sure this will be resolved in due course!.

      Apologies for suggesting you were confused. :)

    3. I'm not sure the inclusion of reserves in the leverage ratio calculation is such an anomaly given that all other claims on public institutions, including treasury bills, have to be included. As soon as you start to exclude one class of asset, you have to decide where to draw the line and you end up introducing new distortions. Given the basic principle behind what the leverage ratio is trying to achieve, I think including everything is probably the best option.

      I made some observations on the "deadwood" issue in my own post

    4. This comment has been removed by the author.

    5. Ah I see its about the role of banks a go-betweens between The central bank and non-banks.
      Also increasing the ratio of banks non risky assets to risky assets by exchanging a risky asset for reserves could possibly deter it from pursuing the same result by seeking new business.

  6. This comment has been removed by the author.

  7. I think one should read up at, if you have some knowledge of banking, it helps to understand how ratios work. In any case, bankers devise their lending strategies based on ratios and standards such as Basel III and Basel IV.

    1. I think one should not, Jon....the money multiplier does not work in the way that article suggests, and reserve ratios do not determine lending strategies.

    2. reserve ratios do not determine lending - True

      Anyway in the UK , the banking system does not have mandated ratios for reserves

      Bank of England

      " The reserves scheme is voluntary....."

      " Participation in the reserves-averaging scheme
      is voluntary other than for CHAPS
      sterling and
      sterling settlement banks, which join the
      scheme automatically because their role in the
      payments system entails their having accounts, and
      so maintaining balances, with the Bank. The level of
      reserves targeted (up to the ceilings set by the Bank)
      is also a choice for individual scheme members, made
      monthly ahead of each reserves maintenance period."

      Bankof England Website "explanatory notes wholesale" and "May 2006
      Bank of England
      The Framework for the
      Bank of England’s Operationslend reserv
      in the Sterling Money Markets"

      Banks do not lend reserves to customers , its important to note that they do not lend deposits either.

    3. Thanks Dinero. Indeed I made that point in the post. Banks do not lend either reserves or deposits to customers.

      As Forbes is an American magazine, in Forbes posts I tend to focus more on how the American banking system works. The US does have required reserves.


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