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Why would the Fed allow this? Who created the regulation saying they needed a threshold and why aren't they putting more teeth into it? It seems silly to me to

Why would the Fed allow this? Who created the regulation saying they needed a threshold and why aren't they putting more teeth into it? It seems silly to me to have a regulation without proper enforcement and it seems insane to me that the Fed is complicit.

samsolomon 7y ago
I'm also interested why the FED would want to do this. Could it be to maintain interest rates at a certain target? If the banks don't have money to lend, would it cause them to charge higher interest on their loans?
- PeterStuer 7y ago
  Banks don't actually need money to lend money. They just create a loaned amount credit in one account and a corresponding asset consisting of a future revenue stream on the other side. The cash reserve is just a collateral against the risk, needed to stabilize public trust they will not default at the slightest ill wind.
quickthrowman 7y ago
The banks have assets that are worth money they can post as collateral to borrow the cash to meet reserve requirements. Or would you rather have banks unloading massive stacks of treasuries at market close daily to meet their cash needs, creating volatility in bond markets? Repo lending means banks don’t have to unwind their positions daily due to a cash shortage, because they have other assets they can post as collateral for cash. It’s not a bad thing.
- PeterStuer 7y ago
  Tell me: Why was the cash reserve regulation introduced? What problem did it address? Why, if banks are not able to comply with this regulation without "unloading massive stacks of treasuries at market close daily", are they allowed to load up on "massive stacks of treasuries" flaunting the cash reserve regulation in the first place?
  - MichaelConlon 7y ago
    The cash reserve system was introduced to protect against a 1920's style bank run. The idea being that a bank should have enough liquid assets to cover 10 or 15% of their customers pulling all of their deposited funds out of the bank. The goal of a bank is to make as much money as it can with it's assets. It's in the banks interest to loan out as much as it safely can while staying above the reserve requirements. If a bank were to dump it's assets to ensure it met reserve requirements it would likely sell at firesale prices which could drive down the price of those assets for the rest of the market. By taking a loan from the Fed and using those assets as collateral that scenario is avoided. It's also worth noting that these loans are not free, the Fed does charge interest. So the bank avoids dipping below reserve requirements (and flooding the asset market) and the Fed earns a small amount of interest.
    - apacheCamel 7y ago
      I guess my question would be then why did the bank originally allow themselves to loan too much out? From what you said, it seems like they loaned too much out and without the Fed they would then have to dip into their assets to meet the regulation. So it still seems like the bank messed up and the Fed is bailing them out (despite with interest). I agree it would be a problem for them to dump the assets but it also seems like a problem they are in this situation to begin with.
      - MichaelConlon 7y ago
        You're correct in that it means that the bank messed up. The idea is that this is for (relatively) small amounts to cover reserve funds for a short period of time. This may happen because large deposit accounts decided to withdraw unexpectedly or loan repayments stopped coming in. Ideally this is to be used for a day or maybe a week. However, you're correct that there is certainly potential for abuse in the system if a bank is doing this repeatedly every day for months or more. I'm not sure what, if any, measures are in place to prevent that abuse.

samsolomon 7y ago

I'm also interested why the FED would want to do this. Could it be to maintain interest rates at a certain target? If the banks don't have money to lend, would it cause them to charge higher interest on their loans?

PeterStuer 7y ago
Banks don't actually need money to lend money. They just create a loaned amount credit in one account and a corresponding asset consisting of a future revenue stream on the other side. The cash reserve is just a collateral against the risk, needed to stabilize public trust they will not default at the slightest ill wind.

quickthrowman 7y ago

The banks have assets that are worth money they can post as collateral to borrow the cash to meet reserve requirements. Or would you rather have banks unloading massive stacks of treasuries at market close daily to meet their cash needs, creating volatility in bond markets? Repo lending means banks don’t have to unwind their positions daily due to a cash shortage, because they have other assets they can post as collateral for cash. It’s not a bad thing.

PeterStuer 7y ago
Tell me: Why was the cash reserve regulation introduced? What problem did it address? Why, if banks are not able to comply with this regulation without "unloading massive stacks of treasuries at market close daily", are they allowed to load up on "massive stacks of treasuries" flaunting the cash reserve regulation in the first place?
- MichaelConlon 7y ago
  The cash reserve system was introduced to protect against a 1920's style bank run. The idea being that a bank should have enough liquid assets to cover 10 or 15% of their customers pulling all of their deposited funds out of the bank. The goal of a bank is to make as much money as it can with it's assets. It's in the banks interest to loan out as much as it safely can while staying above the reserve requirements. If a bank were to dump it's assets to ensure it met reserve requirements it would likely sell at firesale prices which could drive down the price of those assets for the rest of the market. By taking a loan from the Fed and using those assets as collateral that scenario is avoided. It's also worth noting that these loans are not free, the Fed does charge interest. So the bank avoids dipping below reserve requirements (and flooding the asset market) and the Fed earns a small amount of interest.
  - apacheCamel 7y ago
    I guess my question would be then why did the bank originally allow themselves to loan too much out? From what you said, it seems like they loaned too much out and without the Fed they would then have to dip into their assets to meet the regulation. So it still seems like the bank messed up and the Fed is bailing them out (despite with interest). I agree it would be a problem for them to dump the assets but it also seems like a problem they are in this situation to begin with.
    - MichaelConlon 7y ago
      You're correct in that it means that the bank messed up. The idea is that this is for (relatively) small amounts to cover reserve funds for a short period of time. This may happen because large deposit accounts decided to withdraw unexpectedly or loan repayments stopped coming in. Ideally this is to be used for a day or maybe a week. However, you're correct that there is certainly potential for abuse in the system if a bank is doing this repeatedly every day for months or more. I'm not sure what, if any, measures are in place to prevent that abuse.