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U.S. Banking Reserves in Trouble

January 30, 2008

During periods of credit-tightening in financial and commercial banking operations, commercial banking members or depositors often need to borrow funds to meet reserve requirements based on the fractional reserve in order to continue to operate.

fedborrowedreservesinet.jpgBorrowed reserves show as a negative number in financial reports of the Federal Reserve. Borrowed reserve statistics measure the degree that commercial banks have been required to secure funding from the Federal Reserve Bank to obtain the required fractional reserves for loans. When loans are made, the fractional reserve (currently 10%) is set aside as a deposit to secure the loan within the banking system. Additional loans are made based on the reserves on hand in each member bank. The typical problem in a shrinking credit market is that when loans in default must be posted to the bank ledger. When these loans are posted against the ledger, the fractional reserve funds on hand are removed from the ledger. In turn, this creates a bank liquidity problem and the member bank can quickly become underfunded to meet daily banking system requirements. Underfunded banks are unable to make loans to their customers.

Current banking practice dictates that when a bank has excess reserves from creating so many loans, a financial institution can sell their excess reserves to other banking members. If the bankers are short on reserves, like in the current market, a dash to find reserves can ensue. Sometimes, the bankers cannot find reserves within the commercial banking system and must obtain the required reserves from the Federal Reserve Bank. In an extreme market crisis, the Fed may use creative funding methods. Recently, the Federal Reserve began to offer funds for auction in order to create a reserve infusion within the banking system so that commercial banks can continue to make loans to qualified customers and continue doing business.

In the case of this recent ongoing auction, funding will show as negative numbers as banking credits are moved into the banking system. In this scenario, the Fed policy innovation has an additional side effect. The commercial banking system is guaranteed by the U.S. government to depositors. In the case of such a closure, the funding comes from the Fed and is posted to federal deficit. Any expenses not covered by commercial banking from the transfer of credit (actually debt) to the commercial banking system is actually posted to the ledger of the ever-increasing federal deficit. Which banks are receiving the assistance of the Federal Reserve? That is top secret. The Fed does not want to create a panic for banks that have needed the extra infusion of operating capital.

Federal Reserve Research Chart Data
Federal Reserve Aggregate Research Material

Elvis Manning
TNTalk!

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One Comment leave one →
  1. February 2, 2008 11:19 am

    hopefully all the rate cuts will help

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