As we move forward with the Fed's balance sheet shrinkage we will have posts discussing repo and reverse repo, the Treasury General Account, reserves and required reserves, interest on banks' reserve balances held at the Fed and all sorts of other stuff that has its own nomenclature.
From Bond Economics (also on blogroll at right), September 6:
Bank reserves feature prominently in Economics 101 discussions of banking. As is entirely typical for Economics 101 macroeconomics, the topic is either taught incorrectly or in a misleading fashion. Bank reserves — better referred to as “settlement balances” — are just private sector bank deposits at the central bank. If you know what a bank deposit is, you know what a “bank reserve” is.
One initial tangential point is that what I am referring to are no loan loss reserves taken by banks. In a country like Canada where reserve requirements were abolished in the 1990s, loan loss reserves might be the only “reserves” that comes up in conversation outside of macroeconomic circles. A loan loss reserve is an estimate of future credit losses on a bank’s loan book — they are holding a “reserve” against the value of assets that are held at book value.
For simplicity, I am not going to attempt to get into the details of payments systems. For out purposes, we can simplify the situation to be that private banks hold deposits at the central bank, and when they need to transfer money to each other, this is done via a transfer of between deposit accounts. If the private bank needs to wire money to/from the central government, the deposit balance is reduced/increased. Note that although the banks will sometimes transact on their own account, they are mainly acting as agents on behalf of their customers. That is, if a customer needs to pay a $100 tax bill to the central government, the bank will reduce the customer’s deposit balance by $100 and then “transfer” the money to the government (which just reduces the private bank’s balance at the central bank).
(If we do want to worry about payment systems, there is a new entity introduced into transactions. Banks — both private and the central bank — send payments to each other via the payments system. However, net transactions are supposed to net out to zero, and so if we look at end-of-day balance sheets, the payments system is not supposed to be visible. If it is, something has probably gone horribly wrong.)
Dealing With Misunderstandings
Once we realise that “reserves” are just a type of asset held by private banks, a lot of points of confusion should be dissipated. The most typical problem is the idea that “banks lend reserves” to non-banks. Since non-banks are normally precluded from holding deposits at the central bank, there is no way for a bank to transfer a “reserve” to that customer. (Banks can “lend reserves” to each other in inter-bank markets.)....
....MUCH MORE
