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| John & Mac - First of all, I must put a disclaimer on this post as much of it is an educated guess of what and how other banks are behaving. IE) We are NOT them, so I could be very wrong in some of the inferences I am making in this post, and therefore do so somewhat reluctantly.
We are not a Fed member bank, so our reserves are held with correspondent banks, not the Fed. The reserve requirement that our correspondent bank has with the Fed comes back to us in the form of reserves that we keep at the correspondent bank. I am pointing this out b/c all banks must ultimately hold reserves as an asset whether they are a Fed Member bank or not. The difference is the Fed Member bank has to keep the minimum Reserve with the Fed whereas a country bank like us maintains the Reserves with a correspondent bank, not the Fed. The correspondent bank is likely going to pass their Reserve Requirement with the Fed onto the various country banks that it is acting as a correspondent bank for. Therefore, if the Fed raises their Reserve Requirement, it is likely that the correspondent will do the same to us.
Reserves are different than capital. Reserves are assets. There are basically two types of Reserves. The first type is Required by the Fed and is defined as a percent of a bank's deposits which may change from time to time by the Fed. Today, these amounts are a relatively small part of the overall Reserves that are currently deposited with Fed by Fed Member banks. The second type is called Excess Reserves and are deposited with the Fed in ADDITION to the Reserve Requirement portion.
I believe the primary reason you are seeing huge Excess reserves are two fold, although I must again point out that I am not privileged to the other banks' thinking or strategies.
The first one is simply that loan demand is soft. So, rather invest it in a short-term Treasury Bills which are paying next to nothing, why not keep it totally liquid and deposit the money with the Fed (also earning next to nothing with the advantage of being totally liquid) until loan demand picks up?
The second reason is a bit more concerning. In normal times banks deposit money to each other where perhaps they can get paid a bit more interest than depositing it directly with the Fed. The problem likely goes back to lingering effects from the collapse of Lehman Brothers. Banks deposited excess Funds at Lehman Brothers and Lehman, in turn, would likely use the money to fund loans. So, both institutions would gain. Lehman was able to fund more loans with the excess funds and the correspondent bank would receive slightly higher interest than they would receive at the Fed. However, we know what happened. Lehman was allowed to fail.
Simply put as I can, I suspect you are witnessing the effects of a changed paradigm. Why would Bank A lend to Bank B who can fail for only a slightly higher amount of interest? So, Bank A likely strategically decides to redirect their Excess Funds directly with the FED whose failure can only come if the entire system fails. This creates a problem for Bank B that used to have the benefit of Bank A's excess funds. They now have to go to FED directly and borrow money to make up the shortfall. This means that FED has become a Bank of first choice and that it has to do a lot more lending to banks who need the money that was taken away from them by Bank A types and simultaneously receives a lot more money from Bank A types in the form of excess funds. Hence, the bloated the Reserves appear on the FED's books.
John - you are correct. Our lending decisions have a lot more to do with the capital that we maintain (12%) than the small amount of excess funds we need to keep with correspondents. We are also an S Corporation. What this means is that we grow our capital with Tax Exempt Bond income as we get stepped up basis from the tax exempt income. Therefore, our total loan volume is limited by the large amount of tax exempt bonds we must keep on hand to grow the capital of the bank. We can only take on so many deposits or we will exceed the self imposed 12% capital ratio. Assets of the bank must be funded either with capital, deposits or other borrowings, and they are therefore limited by the capital requirement as well. Reserves have virtually NO impact on our loan volume or lending decisions. It is all controlled by capital requirements. Obviously, the smaller the percentage of capital a bank is willing to run with, the larger the balance can be, so loan volume would be greater in a bank running on 8% capital as compared to our 12%. It is also much more risky to run with lower capital requirements if we encounter economic instability. You will fail much easier. | |
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Loans make deposits II
