>banks finance their balance sheets after their initial capital from liabilities<
this neither refutes nor addresses anything i said.
>they borrow short term and lend long term.<
>I don’t know how to explain a system to someone who has a flawed understanding of the system.<
is this a form of argument? just let your statements speak for themselves, you don't need to say stuff like that, it doesn't advance the discussion and means nothing.
>according to you there are no bounds to the amount of lending the system can do as long as the fed keep feeding the system with the reserves……Then what the point of having reserve requirements?<
banks will continue to make loans as long as they see profitable loan opportunities. they are restrained by their capital, and by the presence of sound credits to lend to.
capital requirements are of both a regulatory nature as well as a market nature. how much leverage over capital is prudent and/or legal is up to the bank, subject to all the vicissitudes of market mania, moral hazard and human folly.
whether the system can go on like this is subject to any number of factors, economic and non economic. i haven't made any statements addressing the longevity of such a system in the real world.
however, that is how the system works. banks don't lend money. banks create loans. there is a difference.
banks are not hindered by reserves or cash from creating loans.
if someone walks in and wants a loan, the underwriter stamps approval, creates 100k in bank money and deposits it in the account of that person. the loan is an asset and a receivable, the money is placed in the borrowers count as a deposit and is a liability. the bank creates a loan (asset) and a deposit (liability) at the same time, expanding its balance sheet.
what is the point of reserve requirements? its a policy tool, like the interest rate. it is an artifact from when reserves were physically limited by gold deposits, when the money supply was tied to gold. the fed manages interest rates by setting the overnight rate on reserve borrowing. they engage in QE by buying US govt securities off bank balance sheets (swapping them for reserves). this allows them to target rates further out on the curve (longer term).
reserves are used to manage clearing operations. settling balances between member banks.
just do a simple thought experiment. if the Fed required banks hold 20% instead of ten percent bank reserves, what would happen? every bank would be over the legal limit, they would bid over the FFR, and the Fed would do OMO to add reserves to hit their target.
it wouldn't reduce loans or constrain loans. the FED always provides whatever amount of reserves are demanded by the banking system at the rate they set. if they set the rate at 5%, they provide whatever amount is demanded at 5%.
likewise, no amount of excess reserves can cause a bank to issue a loan it wouldn't otherwise issue based on its capital levels and underwriting procedures. banks don't worry about reserves. they're a policy tool of the central bank. banks are interested in credit quality and capital levels.
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