Why bank deposits are piling up at the ECB
Email from JJ Lando, now at Nomura:
“THE LTRO DIDN’T DO ANYTHING. ALL THE MONEY WOUND UP AS DEPOSITS AT THE ECB” “QE DIDN’T DO ANYTHING. ALL THE MONEY BECAME EXCESS RESERVES BACK AT THE FED.”
(Apologies in advance to all who have heard me give this one ten times before)
- Central Banks, whenever they buy any asset (eg lend eg grow balance sheet) create new reserves.
- Commercial banks and people do NOT have the capacity to destroy those reserves. Once the Fed or ECB wires the money or creates that asset line item on its spreadsheet, there is an equal and offsetting liability on its spreadsheet called reserves. This spreadsheet cannot be broken.
- All that commercial banks can do is lending, which moves some of those reserves from ‘excess’ to ‘required’ but they are still there.
- Commercial Banks make this lending decision based upon regulatory capital and profit motives, not based upon reserves. They have a ‘captive audience’ in their Central Banks, who MUST create the necessary reserves (a floored amount) to prevent interest rates from going to infinity.
- When a Central Bank does a lot of Balance Sheet expansion in a short time, it’s going to wind up as deposits/excess NO MATTER WHAT. If the Fed does 1T of QE, Banks don’t suddenly ‘find’ the regulatory capital to make 10T of loans. And even if they did, there would be the SAME AMOUNT OF TOTAL RESERVES.
- Bank lending to a 0% risk weighted sovereign actually does NOTHING to diminish excess reserves.
- Simplified Illustration: ECB does a very large unsterilized LTRO. They take a lot of sov paper on balance sheet (temporarily), and they wire NEW FUNDS to the member banks. Those member banks take some of the money and buy paper from the Italian government. That government spends the money by wiring it to its pensioners. Those pensioners take it to buy food from the local grocer. The local grocer DEPOSITS IT IN HIS BANK. SOMEWHERE DOWN THE CHAIN the money winds up on deposit in some member bank, be the chain long or short. WHATEVER MONEY THE ECB CREATES WINDS UP ON DEPOSIT IN ITS MEMBER BANKS, WHETHER OR NOT IT IS ‘USED’ TO BUY SOVEREIGN DEBT, ‘USED’ TO MAKE LOANS, OR NOT USED AT ALL.
- Please. I never wish to read again that ‘Central Bank money went unused because it wound up as deposits.’ IT HAS NOWHERE ELSE TO GO. THE BANKING SYSTEM IS A CLOSED LOOP. With the possible exception of someone making a withdrawal, taking the paper, and making a bonfire (actually not feasible in the hundreds of billions anyway because there are constraints)
- And that is probably how Italy just managed to borrow at 1.64%
Good luck!
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ECB does a very large unsterilized LTRO. They take a lot of sov paper on balance sheet (temporarily), and they wire NEW FUNDS to the member banks. Those member banks take some of the money and buy paper from the Italian government.”
I do not understand this. LTRO creates excess reserves (as you describe in point 1.). How can it be used for buying Italian bond?
The central bank gave the euro banks reserves in LTRO. The banks can either sit on those reserves or swap them for another asset.
Thanks for the answer Edward.
Ok, they swap. But the total amount of reserves in the banking system will not change with the swap transaction. Also the total amount of “other asset” (e.g. Italian bond) will not change. This means no additional financing of the Italian government is taking place. LTRO or any QE, repo will not help buying additional assets for the banking system (just swap), only increases the amount of reserves.
This is what I do not understand. What is the real effect of QE, LTRO except of pushing up the asset prices?
LTRO is a liquidity operation. The inter-bank lending and commercial paper markets are shut and so the ECB has taken on lending to banks that used to happen via money market funds and inter-bank lending. The banks can do what they want with the funds that they receive in these operations but it is as you say, not as if more money is suddenly available for buying sovereign paper.
>Please. I never wish to read again that ‘Central Bank money went unused because it wound up as deposits.’ IT HAS NOWHERE ELSE TO GO. THE BANKING SYSTEM IS A CLOSED LOOP. With the possible exception of someone making a withdrawal, taking the paper, and making a bonfire (actually not feasible in the hundreds of billions anyway because there are constraints)
I think you’ll find that reserves can flow to non-bank accounts at the ECB moving them out of this “closed loop”. Foreign central bank accounts for example.
However, the important part of the ECB’s data is actually the marginal lending facility, not the deposit facility. The fact that the marginal lending facility is still seeing action while there are so many excess reserves is the issue. Draghi admitted in his press conference that the interbank market isn’t working, so reserves aren’t flowing between banks, therefore banks with withdrawal demands cannot re-coup required reserves in the usual way ( by lending them in the interbank market ).
The first part of your argument is factually inaccurate. Bank reserves cannot flow to foreign central banks. bank reserves are held by participating financial institutions within an individual banking system.
For example, the ECB cannot hold bank reserves in the US banking system. The reserves you refer to that central banks hold are foreign reserves, not bank reserve. And that’s a completely different kettle of fish.
>The first part of your argument is factually inaccurate. Bank reserves cannot flow to foreign central banks. bank reserves are held by participating financial institutions within an individual banking system
I didn’t say that reserves flowed to foreign central banks, I said they could flow to central bank accounts owned by foreign central banks within the same reserve bank.
>And that’s a completely different kettle of fish.
A reserve is a reserve, so I am not sure what you are trying to say.
No, foreign reserves are not at all the same as bank reserves. They are completely distinct.
See here for an explanation:
https://en.wikipedia.org/wiki/Foreign-exchange_reserves
Foreign reserves are independent of the domestic banking system and represent aggregate foreign liabilities that have nothing to do with bank reserves.
Edward I am not sure why you decided to introduce another concept into the discussion.
I said ” think you’ll find that reserves can flow to non-bank accounts at the ECB moving them out of this “closed loop”. Foreign central bank accounts for example.” and in this context I said “A reserve is a reserve, so I am not sure what you are trying to say.”,
That is, in this context for example a $US reserves is a $US reserve. Whether it is available in the banking system, and therefore a “bank reserve” is dependent on whether it is held in an account held by a institution that is part of the banking system. These, however, are not the only accounts at the reserve and therefore it is possible, under certain financial transactions, for reserves to leave the “closed loop” of the banking system.
The relevant part of Mr Mossler’s article is this line
> Those member banks take some of the money and buy paper from the Italian government.
Does the Italian treasury have an account within a commercial bank or its own account at the ECB ? If the later, then this operation will remove reserves from the banking system. But either way foreign central banks do maintain reserve accounts at other central banks
From here https://www.rayservers.com/images/ModernMoneyMechanics.pdf
Reserve accounts of depository institutions constitute the bulk of the deposit liabilities of the Federal Reserve System. Other institutions, however, also maintain balances in the Federal Reserve Banks – mainly the U.S. Treasury, foreign central banks, and international financial institutions. In general, when these balances rise, bank reserves fall, and vice versa. This occurs because the funds used by these agencies to build up their deposits in the Reserve Banks ultimately come from deposits in banks
That description of modern money you are referencing is flawed as it assumes that reserves create deposits when in fact they do not since a banking system is not reserve constrained:
https://pro.creditwritedowns.com/2011/05/banks-are-never-reserve-constrained.html
Moreover, I am making a distinction between bank reserves and foreign currency reserves which are not the same. A central banks holdings of dollar reserves is not the same as a domestic institution’s holding of bank reserves. I don’t know how else to explain it.
As soon as one says foreign central bank and reserves in the same sentence, one is not talking about bank reserves. Moreover, bank reserves in a nonconvertible floating rate currency system are used to help the CB hit an interest rate target and not used to expand the deposit base as the article you reference indicates.
The banking system isnt reserve constrained. But it should be. Banks shouldnt be allowed to create money no one should apart from the central bank.
Bank credit contraction will alter some of Mosler’s “rules”.