Bank Reserves: What They Are (And Aren’t)

Reserves ≠ Lending Capacity

Since 2020, reserve requirements are 0%.
Banks don’t lend out reserves; they create deposits when they make loans. Reserves settle bank-to-bank payments.

🏦 What Are Reserves?

Central Bank Money

Balances at the Fed

Base Layer

Settlement Only

Bank-to-bank payments

Not For Lending

Myth: banks lend reserves

Required vs Excess

Requirement now 0%

💳 How Lending Works

Loan First

Then find reserves

Mechanism

Deposit Created

Borrower gets deposit

Reserve Management

Borrow from Fed or other banks

Capital Constraint

Equity ratios (Basel)

🧰 Policy Tools

IOER/IORB

Interest on reserves

Discount Window

Emergency liquidity

Repo/Reverse Repo

Short-term liquidity

QE/QT

Change reserve levels

🔧 What To Know

QE ≠ Bank Lending

Increases reserves only

Important

Credit Demand Matters

Willing borrowers

Capital Ratios

Primary constraint

Rates Dominate

Cost of money rules

Balance Sheet Mechanics (Simple)

Bank makes $100k loan → creates$ 100k deposit (asset + liability)
Borrower spends → funds move to other bank → reserves must settle
If short on reserves, bank borrows at Fed Funds or Discount Window
Capital requirements ensure enough equity to absorb losses

Why People Confuse Reserves and Lending

QE increases reserves dramatically → People assume lending increases
But if demand/capital is weak, lending doesn’t grow
Lending grows when rates low + credit demand strong + capital available