Negative interest rate on reserves

[William Hummel]

Reports today indicate that ECB is considering charging interest on the excess reserves that banks hold in a bid to stimulate more bank lending and boost the economy. With several Eurozone countries in recession now, that seems like a smart move. It would be in sharp contrast to the Fed's paying interest on reserves of 0.25%.

 

If banks had to pay interest on excess reserves, they would no doubt try to pass the costs on in the form of reduced interest rates on the deposits or higher interest rates on loans. Nevertheless I believe negative interest on reserves would make sense in the US under present conditions. Banks have little incentive to take on the risk of lending when they can enjoy a free lunch. With excess reserves of about 1.7 trillion, they receive interest payments from the Fed of about 4.25 billion per year in the aggregate.

 

William  

[Mark Bachmann]

The Fed and the ECB are both in double binds. The purpose of paying interest on reserves in the first place, as I understood it, was to facilitate capital accumulation among banks who had depleted their capital through reckless lending. Charging interest now on excess reserves would seem to be a policy designed to force banks to increase their lending. Yet they would be lending already if there were sufficient prudent opportunities available - a 25 basis point free lunch is not sufficient incentive for them to refrain from real business if it is there. One can argue that banks are stupid, but they're surely not that stupid. There is obviously a dearth of prudent opportunities at the present time, and efforts by CBs to force the matter will, it seems to me,  likely give incentive once again for them to seek out imprudent opportunities and start the perverse cycle all over again.

 

   Mark Bachmann

[Jim Blair]

Hi,

Might this result in banks charging depositors for keeping their money in a bank rather than paying them the (low) interest they now pay?
And I agree with Mark: encouraging banks to make risky loans is what caused the most recent  recession.

Some people seem to think that "low interest rates are GOOD and the lower the better".  GOOD because they encourage people to go into debt to spend, and that "creates jobs".  But while low interest rates benefits borrowers, the down side it that they lower the incomes of savers.  And when "safe" (FDIC insured) money-in-the-bank no longer provides enough income for savers (retirees for example) to live on, they seek higher returns from riskier investments.

Why would the Fed or the ECB encourage people to put their savings into riskier schemes?

Jim

[William Hummel]

From: Jim Blair  Friday, May 03, 2013 8:15 AM

Hi,

Might this result in banks charging depositors for keeping their money in a bank rather than paying them the (low) interest they now pay?

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Yes, that's simply an alternate way for banks to recover the cost of negative interest on reserves.

And I agree with Mark: encouraging banks to make risky loans is what caused the most recent  recession.

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Fraudulent loans (like liar loans) and securitization without oversight were the basic cause, not risky loans per se.

Some people seem to think that "low interest rates are GOOD and the lower the better".  GOOD because they encourage people to go into debt to spend, and that "creates jobs".  But while low interest rates benefits borrowers, the down side it that they lower the incomes of savers.  And when "safe" (FDIC insured) money-in-the-bank no longer provides enough income for savers (retirees for example) to live on, they seek higher returns from riskier investments.

Why would the Fed or the ECB encourage people to put their savings into riskier schemes?

------------

Because banks have been overly cautious in lending and borrowers overly cautious in borrowing since the near collapse of the banking system and the resulting debt deflation. Also the interest paid on reserves reduces the incentive for banks to spend them on new loans.

[William Hummel]

From: Mark Bachmann  Friday, May 03, 2013 5:33 AM

The Fed and the ECB are both in double binds. The purpose of paying interest on reserves in the first place, as I understood it, was to facilitate capital accumulation among banks who had depleted their capital through reckless lending. Charging interest now on excess reserves would seem to be a policy designed to force banks to increase their lending. Yet they would be lending already if there were sufficient prudent opportunities available - a 25 basis point free lunch is not sufficient incentive for them to refrain from real business if it is there. One can argue that banks are stupid, but they're surely not that stupid. There is obviously a dearth of prudent opportunities at the present time, and efforts by CBs to force the matter will, it seems to me,  likely give incentive once again for them to seek out imprudent opportunities and start the perverse cycle all over again.

 

   Mark Bachmann

 

I don't think the purpose of paying interest on reserves was to help recapitalize banks, although it did have that effect. Long before the housing bubble and financial crisis, the Fed had lobbied Congress for authority to pay interest on reserves. They finally succeeded in Oct 2008. The basic argument was that US banks were at a disadvantage against foreign banks, many of which operated with little or no reserve requirement. 

 

That argument is false. Aside from initial purchase out of bank shares, reserves come at no cost to banks, as is obvious from what they have acquired through quantitative easing. Thus unremunerated reserves don't represent a net opportunity cost to banks. That's why IOR with the current huge excess of reserves is a free lunch for banks.

 

William

[Joe Leote]

My theory is that Fed and Treasury are providing a liquidity cushion to Banks and Nonbanks, and that a necessary part of this strategy is Sovereign-sponsored re-capitalization.

The liquidity cushion structure would look something like this:

1. Short term Treasury securities, lowest interest, Nonbank balance sheet
2. Excess Reserves, higher interest, Bank balance sheet
3. Long term Treasury securities, higher interest, Nonbank balance sheet
3. Agency- and GSE-backed securities, highest interest, Bank balance sheet

The Banks get a Fed and Treasury-backed guarantee of the cash flows in their liquidity cushion at higher rates of interest than the Nonbanks.

If banks start expanding assets to reduce excess reserves the size of the bank liquidity cushion relative to the illiquid assets will reverse and begin to decrease. This might be of some benefit in the US but probably not a net long term benefit in Europe.

I am not aware of how much bad debt the banks are holding and wish to write off against future revenue streams rather than take one large charge against "capital" and unsecured liabilities. Those are the two ways to write-off bad loans, all at once, in a Cyprus style "haircut," or get government assistance to clear up the bad bank debts against future revenue as a future expense.

Joe

[helge nome]

The problem is that banks and other financial institutions have been spoiled rotten  by having money handed to them
with no real conditions attached. Is it any wonder that things have gone sideways?
Money is essentially a ticket system which value is created by us all collectively in our endeavors over time.
We, The People, have a fundamental right to a share of that money, rather than simply having the ticket dispensers
distribute it for their own convenience and benefit, at our expense.
Come on guys, don't get blinded by all the detail!

Helge

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Date: Fri, 3 May 2013 12:21:10 -0400
From: tech_a...@verizon.net
To: understan...@googlegroups.com
Subject: Re: Negative interest rate on reserves

[Joe Leote]

Here are ideas for local finance as an alternative:

http://www.gmlets.u-net.com/design/dm1%5E1.html

but there may be problems with finance in any system. The only way to understand the problems is to discover some set of working principles within the social customs. That is, understanding is in the comparison of the system details.

Joe