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The commercial banks deposit their money in the central bank. Normally, the central bank pays (usually quite minimal) interest to the commercial banks for that

The commercial banks deposit their money in the central bank. Normally, the central bank pays (usually quite minimal) interest to the commercial banks for that money. With negative interest rates, the banks' deposits in the central bank start loosing value, i.e. the banks must "pay" the central bank a premium for holding their money. The desired effect of negative interest rates is that commercial banks more readily give out loans to businesses, rather than just keeping their reserves idle, as the potential returns from successful lending are better. The idea is to inject more money in circulation and stimulate economic growth.

rmc 12y ago
Why do the commerical banks store it with the central bank? Why not store it themselves?
- mschuster91 12y ago
  Because at billion-dollar scale even 0.1% is better than 0%.
  - Udo 12y ago
    Not if it's -0.1%.
- pmontra 12y ago
  One of the reasons is the mandatory minimum reserve. Check this http://www.ecb.europa.eu/mopo/implement/mr/html/index.en.html http://www.ecb.europa.eu/mopo/implement/mr/html/index.en.htm... I remembered that reserve existed but I'm a noob at finance so I'm pretty sure there are more important reasons.
- vesinisa 12y ago
  AFAIK, in modern fractional reserve banking the commercial banks enjoy a special privilege for the balance that they hold at their central bank account. The balance at each bank's account is called its reserve, and for every euro the bank holds in reserve, it can actually lend out a far greater sum. Currently, for each euro at its central bank account, a commercial bank can lend out €100 to their clients (borrowers). (Interestingly, this extra money that the bank lends out materializes out of thin air.) So, the banks still have a great incentive to keep their money at their central bank account, because it's the only account that adds to their fractional reserve base.
  - Tycho 12y ago
    I don't think so: banks are capital constrained, not reserve constrained. There's other types of money that make up their capital base as well as central bank reserves.
- yxhuvud 12y ago
  Because the alternatives is basically to store reserves at the central bank or to store them in cash, and storing in cash is costly. The reason for this is that banks within a banking regulation/currency area is a closed system - reserves are created when a loan is made, and cannot be removed from the system until that debt is repaid. A bank can store it in actual cash or in reserves in another bank, but that would simply move the problem to that bank. They need to be able to store their reserves, and they end up doing that at the central bank.
- nhaehnle 12y ago
  In my experience the best way to answer this question is by asking a different question: How do bank transfers work? That is, when you, as a regular person, transfer money electronically from your account to somebody else's, what's actually happening on a technical level? Obviously, both banks that are involved adjust their databases to reflect the change in balances. But now your bank owes you less, and the other person's bank owes their customer more. This is only fair if some form of settlement occurs between the banks. In principle, this settlement could happen in cash, but that would be extraordinarily wasteful (because of the overhead of handling cash). You really want some form of electronic settlement. As a first approximation, the electronic inter-bank-settlement works by all banks having an account at the central bank, and transactions at the consumer level are reflected by corresponding transactions at the level of central bank accounts. (Obviously, reality is more complicated both because it makes sense to aggregate lots of small transactions into a few bigger ones, and because the whole system has grown organically without anybody designing it from first principles.)
Canada 12y ago
Isn't the central bank the lender in this case? It sounds like the idea here is the ECB will loan money to banks at negative interest as long as those funds are loaned out to certain types of borrowers.
- dllthomas 12y ago
  No, the central bank is the borrower (or depository).

rmc 12y ago

Why do the commerical banks store it with the central bank? Why not store it themselves?

mschuster91 12y ago
Because at billion-dollar scale even 0.1% is better than 0%.
- Udo 12y ago
  Not if it's -0.1%.
pmontra 12y ago
One of the reasons is the mandatory minimum reserve. Check this http://www.ecb.europa.eu/mopo/implement/mr/html/index.en.html http://www.ecb.europa.eu/mopo/implement/mr/html/index.en.htm... I remembered that reserve existed but I'm a noob at finance so I'm pretty sure there are more important reasons.
vesinisa 12y ago
AFAIK, in modern fractional reserve banking the commercial banks enjoy a special privilege for the balance that they hold at their central bank account. The balance at each bank's account is called its reserve, and for every euro the bank holds in reserve, it can actually lend out a far greater sum. Currently, for each euro at its central bank account, a commercial bank can lend out €100 to their clients (borrowers). (Interestingly, this extra money that the bank lends out materializes out of thin air.) So, the banks still have a great incentive to keep their money at their central bank account, because it's the only account that adds to their fractional reserve base.
- Tycho 12y ago
  I don't think so: banks are capital constrained, not reserve constrained. There's other types of money that make up their capital base as well as central bank reserves.
yxhuvud 12y ago
Because the alternatives is basically to store reserves at the central bank or to store them in cash, and storing in cash is costly. The reason for this is that banks within a banking regulation/currency area is a closed system - reserves are created when a loan is made, and cannot be removed from the system until that debt is repaid. A bank can store it in actual cash or in reserves in another bank, but that would simply move the problem to that bank. They need to be able to store their reserves, and they end up doing that at the central bank.
nhaehnle 12y ago
In my experience the best way to answer this question is by asking a different question: How do bank transfers work? That is, when you, as a regular person, transfer money electronically from your account to somebody else's, what's actually happening on a technical level? Obviously, both banks that are involved adjust their databases to reflect the change in balances. But now your bank owes you less, and the other person's bank owes their customer more. This is only fair if some form of settlement occurs between the banks. In principle, this settlement could happen in cash, but that would be extraordinarily wasteful (because of the overhead of handling cash). You really want some form of electronic settlement. As a first approximation, the electronic inter-bank-settlement works by all banks having an account at the central bank, and transactions at the consumer level are reflected by corresponding transactions at the level of central bank accounts. (Obviously, reality is more complicated both because it makes sense to aggregate lots of small transactions into a few bigger ones, and because the whole system has grown organically without anybody designing it from first principles.)

Canada 12y ago

Isn't the central bank the lender in this case? It sounds like the idea here is the ECB will loan money to banks at negative interest as long as those funds are loaned out to certain types of borrowers.

dllthomas 12y ago
No, the central bank is the borrower (or depository).