I think I have this right.
Reserves are very much like deposits, except deposits are between a bank and its customers, and reserves are between the central bank and its customers. The Fed creates money from nothing, to lend to banks. Banks create money from nothing, to lend to their customers. Deposits are not loaned out; neither are reserves. Deposits stay in the banking system unless withdrawn as cash. So do reserves.
It's a two-tiered structure of banking. The structure is generally the same, but on two different levels. Looking at it this way, reserves make sense to me.
11 comments:
Mixing apples and oranges. Reserves are considered on the balance sheet of banks as assets. Deposits are liabilities.
The deposits are assets for the bank's customer though, right? Are the reserves a liability for the central bank?
Thanks, O.T.
I've dealt with banks and deposits, so I have some understanding of them.
I have never dealt with reserves or the Fed, so every time the subject comes up I am at a loss. I'm trying to make sense of reserves by comparing them to deposits.
I think Jerry is testing the idea that reserves are a liability for the Fed and an asset for the Fed's customers... and that deposits are a liability for a Bank and an asset for the Bank's customers. So for my comparison of reserves and deposits, the hierarchy is the same, and -- at the customer level -- both the reserves and the deposits are assets. This would be great, because it adds one more similarity to what I said in the post. (And please DO let me know if I'm wrong.)
Thank you both.
Yes, from a very generalized definition reserves are a FED liability. But they are very specialized and unique and only serve as a secure and liquid form of money that banks use for transactions with one another and to meet regulatory requirements. Equating them to private sector financial liabilities through some hierarchy would be a mistake. FED reserves are only fungible within the banking sector and allow the FED to use them to implement Monetary Policy by adjusting reserve levels through open market operations and setting the interest on reserve balances (IORB).
Oh, this is good. You've got me looking things up, searching for things I remember finding before, trying to understand this one way or the other.
I am comparing the central bank and its customers -- banks -- to any one of those banks and its customers -- depositors. I am saying that in quite a few ways, the relation between my bank and the central bank looks similar to the relation between me and my bank.
I spent way too much time today with an old PDF, "Repeat After Me: Banks Cannot And Do Not "Lend Out" Reserves" from 2013. It was way more interesting than I expected. But now I gotta go and un-cross my eyes!
This is long but it outlines what I think what you are asking. It may look similar but the relationship between the Federal Reserve and private banks is fundamentally different from the relationship between private banks and depositors in terms of power dynamics, purpose, and structure.
Federal Reserve & Private Banks
Regulatory & Lender Role:
The Federal Reserve (the Fed) acts as the central bank of the U.S., regulating and overseeing private banks.
It controls the money supply, sets interest rates, and ensures financial stability.
Private banks can borrow from the Fed, especially during crises, through mechanisms like the discount window or emergency lending.
Reserve Requirements & Monetary Policy:
The Fed sets reserve requirements, which dictate how much money banks must keep in reserve versus how much they can lend.
It influences bank lending through open market operations (buying and selling government securities) and setting the federal funds rate (the interest rate at which banks lend to each other overnight).
Membership & Oversight:
Many private banks are members of the Federal Reserve System, meaning they must comply with its regulations.
The Fed ensures the stability of the banking system, acting as the "lender of last resort."
Private Banks & Depositors
Customer Relationship & Deposits:
Private banks provide services like savings accounts, checking accounts, loans, and investment options to depositors.
Depositors place their money in banks, expecting security, liquidity, and interest (if applicable).
Lending & Profit Model:
Banks use deposits to fund loans
They make a profit from the interest rate spread (charging borrowers higher interest than they pay on deposits).
Deposit Insurance & Trust:
Unlike the Fed-private bank relationship, depositors rely on FDIC insurance (up to $250,000 per account) to protect their money if a bank fails.
The relationship is voluntary, as depositors can choose different banks, while banks must comply with Federal Reserve policies.
Essentially, the Fed ensures systemic stability, while private banks focus on profitably managing depositor funds and providing financial services.
Hey, Slick.
Under your heading "Lending & Profit Model" you say "Banks use deposits to fund loans"
The Standard & Poor's PDF from 2013 -- "Repeat After Me: Banks Cannot And Do Not "Lend Out" Reserves" (15 pages) says "banks create deposits when they lend."
They use an accounting identity as "proof" of their statement.
Turning the accounting identity into words, they say:
"Banks lend by simultaneously creating a loan asset and a deposit liability on their balance sheet."
and
"The loan is not created out of reserves. And the loan is not created out of deposits: Loans create deposits, not the other way around."
I accept the view that lending creates money (and repayment of debt destroys money). But if the bank gives me a loan and I want it as cash, then they have to come up with the cash. They have to "fund" it. That's what you said, O.T.
They have to get the money from somewhere.
I think that when I deposit cash in the bank, the bank converts my money to an accounting notation. Now I don't have cash anymore. Now the bank has the cash. The bank puts the money in its vault where they keep it for their own use. The bank can give me or other people cash from this pool of funds it holds, if we withdraw cash. I don't have trouble with this view.
Again: When I put cash in the bank, it becomes the bank's cash to use when they need cash.
I have some trouble with "Banks use deposits to fund loans" because it sounds like the accounting identity might *not* be true.
And I have a lot of trouble with "Loans create deposits" because it is used to bully people into accepting half a thought and to bully people into rejecting the "deposits fund loans" view, which I think is also true.
Since banks need capital to operate, deposits are the cost-effective capital
compared to borrowing money from other institutions or issuing bonds, customer deposits are usually a much cheaper way for banks to fund their activities. So "deposits fund loans"
deposits are the most cost-effective capital
Yup: deposits fund loans. Because "simultaneously creating a loan asset and a deposit liability on the balance sheet" does not create funds. Yup. Now it's making sense.
And yes, "deposits are the most cost-effective capital". I read that a while back but it makes sense now.
Thanks for taking the time with me on this.
Private banks cannot expand without access to affordable capital. It is the only way they can grow their balance sheet. Which is why loan quality is so important, if they have to take a mark to market write down on the asset it does not reduce the deposits. When assets are worth less than deposits insolvent. Glad this helped.
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