The Federal Reserve Bank of New York today released "Why Are Banks Holding So Many Excess Reserves?", the latest article in its series Current Issues in Economics and Finance.
Authors Todd Keister and James McAndrews show that while the high level of reserves in the U.S. banking system during the financial crisis reflects the large scale of the Federal Reserve’s policy initiatives, it conveys no information about the effect of these initiatives on bank lending or on the level of economic activity.
Through a series of examples, Keister and McAndrews explain that the buildup of reserves in the banking system is a by-product of the liquidity facilities and other credit programs introduced by the Federal Reserve in response to the crisis. The majority of the newly created reserves necessarily end up being held as excess reserves and, therefore, the data on excess reserves provide no useful insight into the lending decisions and other activities of banks.
The authors also note the importance of paying interest on excess reserves, which allows a central bank to maintain its influence over market interest rates independent of the quantity of reserves in the banking system, particularly during the recovery from a financial crisis.
Todd Keister is an assistant vice president and James McAndrews a senior vice president in the Monetary and Payment Studies Function of the Federal Reserve Bank of New York’s Research and Statistics Group.