*Stephen G. Cecchetti and Kermit L. Schoenholtz *: The Brave New World of Monetary Policy Operations: "An analysis by Fed economists in early 2017 assumed that by 2022, reserve demand would stabilize at roughly $100 billion. However, just two years later, in March 2019, a Fed survey concluded that banks were likely to want well over $1 trillion in reserves. What accounts for this gap?...
...The answer is liquidity regulations. Today, banks must hold significant liquid assets to back various sorts of short-term liabilities. The details of the Liquidity Coverage Ratio (LCR) are complex, but the basics are simple: banks need to hold some combination of reserves and U.S. Treasury securities to guard against deposit outflows in times of stress. That is, prior to going to the Fed to borrow, these new regulations envision that banks will use the liquid assets they have on hand to meet withdrawals.
...In practice, it turns out that banks prefer to hold reserves than securities to insure against the possibility of outflows. There are several reasons for this. First, if securities―even U.S. Treasuries―are sold quickly, it can drive prices down (something that banks’ own liquidity stress tests may assume). Second, everyone finds out when someone is selling securities under stress. If a bank uses reserves to meet withdrawals, only the Fed knows. The mix of liquidity considerations and the stigma from large Treasury sales makes reserves very attractive...
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