when a bank receives a deposit it enters this on its balance sheet as a liability, with a corresponding entry on its balance sheet as an asset in the form of CASH……this is the basis of their RESERVES……it’s called cash. Therefore its reserve position DID increase from which new loans could be made. In a 10:1 ratio………. 9 dollars of new loans for every dollar in CASH (reserve) it received from it new liability can be loaned out.....but that doesn't mean it has to....but if the bank want to make money it will loan it out. Now if they were stupid and lent out that last dollar…..then they would be deficient in their reserve requirement with the Fed…….if you keep being deficient in your reserve requirements this brings out the auditors……if there one thing a banker hates it’s an audit. The reserves are kept in defense of your shareholder equity in the case of asset impairment. Assets can decline in value…..but the liabilities never decline in value……shareholder equity does.
Case in point…….bank A levers up its balance sheet 20 to 1 with questionable assets called CDO’S. , finance first by shareholder equity and then by taking on liabilities to make as much profit as possible.
The 20:1 ratio reduces the number of shares outstanding (and shareholder capital by defination) so that the larger profit by using so much debt leverage only has to be shared with the least amount of shareholders. This is the old M&M model of proper capitalization found in those musty old finance text books. But anyway……so the day comes and loans start going bad. Well it will only take a 5% decline in those CDO (if anyone needs a further explanation on bond valuation just e-mail me……that includes you to Bill) to wipe out shareholder equity……..because the bank didn’t keep enough reserves (Cash) for a raining day. Oh and by the way……it wouldn’t have to take a decline in the bank’s assets…..what if you had a run on the banks with 5% equity and no reserves…….bankrupt.
From the Federal Reserve website
Reserve requirements are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. Within limits specified by law, the Board of Governors has sole authority over changes in reserve requirements. Depository institutions must hold reserves in the form of vault cash or deposits with Federal Reserve Banks.
The dollar amount of a depository institution's reserve requirement is determined by applying the reserve ratios specified in the Federal Reserve Board's Regulation D to an institution's reservable liabilities (see table of reserve requirements). Reservable liabilities consist of net transaction accounts, nonpersonal time deposits, and eurocurrency liabilities. Since December 27, 1990, nonpersonal time deposits and eurocurrency liabilities have had a reserve ratio of zero.
The reserve ratio on net transactions accounts depends on the amount of net transactions accounts at the depository institution. The Garn-St Germain Act of 1982 exempted the first $2 million of reservable liabilities from reserve requirements. This "exemption amount" is adjusted each year according to a formula specified by the act. The amount of net transaction accounts subject to a reserve requirement ratio of 3 percent was set under the Monetary Control Act of 1980 at $25 million. This "low-reserve tranche" is also adjusted each year (see table of low-reserve tranche amounts and exemption amounts since 1982). Net transaction accounts in excess of the low-reserve tranche are currently reservable at 10 percent.
So let me ask you a question Bill. In 2008 there was a financial crisis that was on its face a liquidity problem as opposed to a solvency problem (we can debate that at another time). So why didn’t the Fed just flood the system with reserves. If it is limitless……and the banks were suffering from a lack of liquidity. Under you logic they could have papered it over with not a worry…….banks would have continued to lend without regard to reserves……didn’t matter if asset prices were declining……just add more reserves…….their only lending decisions was only who needed a loan………EVERYONE DID!
I am sorry Bill but Tom Woods in correct and you are boring me to death because of your lack of any attempt to understand......if you think we live in a world on endless money creations......either by printing or loans......i have got some loans that need you to finance for some carry trades......do you have enough in reserve or will you need to check with the Fed.
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