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The strange world of reserve requirement ratios, transaction accounts and capital /asset ratios
1) According to U.S. law, all U.S. banks must maintain a certain amount of reserves to cover its loans to customers. Whether or not these reserves serve any purpose is a matter of debate we can leave for another time. The fact is that these requirements are part of banking laws and they should be observed until those laws are changed. I personally am convinced that these laws are not being followed -- so perhaps this is a moot issue. (mrc)
See: The strange world of reserve requirement ratios, transaction accounts and capital /asset ratios
2) The following reserve requirement ratios are prescribed for all banks. The numbers come from § 204.9 (e) of << http://www.fdic.gov/regulations/laws/rules/7500-500.html >>, a federal law. Scroll down to the links under "regulations" 204.9 for "Reserve requirement ratios".
3) "Net Transaction Accounts" is basically the dollar value of all customer's deposits and accounts receivable on the bank's books. The precise definition of transaction account comes from § â202 Definitionsâ of the URL immediately above: (scroll down at the URL to the links under 'regulations' § 204.2 --'definitions') it is reproduced directly below at 4).
4) '(e) Transaction account means a deposit or account from which the depositor or account holder is permitted to make transfers or withdrawals by negotiable or transferable instrument, payment order of withdrawal, telephone transfer, or other similar device for the purpose of making payments or transfers to third persons or others or from which the depositor may make third party payments at an automated teller machine ("ATM") or a remote service unit, or other electronic device, including by debit card ... "
5) The "Reserve Requirement" for a bank with no deposits is basically the cash the bank has on hand, plus the money it has on deposit at the Federal Reserve.
6) TABLE "A" -- 204.9 Reserve Requirement Ratios
Net Transaction Accounts Reserve Requirement
$0 to $9.3 million 0 percent of net accounts.
Over $9.3 million and up to $43.9 million 3 percent of net accounts.
Over 43.9 million $1,038,000 plus 10 percent of
net account amount over $43.9 million.
7) In other words, if a bank has a total of $50 million of (a) customer's deposits and (b) loans to borrowers on its books, it must have $1,099,000 as a reserve [$1,038,000 + $61,000 (10% of $6,100,000)].
8) That $1,099,000 is about 2.2% of the $50 million. That means such a bank can lend about 45 times as much money as it has in "net accounts".
9) Note that the bank needs zero reserves if it has up to $9 million dollars in loans out to customers. In other words, if a bank has none of its own money in the bank -- it can still lend out up to $9 million.
10) § 204.9 Reserve requirement ratios (in text form)
11) The following reserve requirement ratios are prescribed for all depository institutions, banking Edge and agreement corporations, and United States branches and agencies of foreign banks:
12) For a net "Transaction Amount" (TA), the "Reserve Requirement" (RR) is in accordance with the following text.
For a TA of $0 to $9.3 million, the RR is 0% of TA
For a TA of $9.3 to $43.9 million, the RR is 3% of TA
For a TA over $43.9 million, the RR is $1,038,000 + 10% of amount over $43.9 million
13) U.S banks are evidently also bound by the Basel II Capital Accord according to a 11/01/07 news release from The Office of the U. S. Comptroller of the Currency.
<<http://www.occ.gov/ftp/release/2007-123.htm>>
This accord specifies a capital / asset ratio
(see << http://wfhummel.net/capitalrequirements.html >>) for a discussion. We believe the description at that link is accurate. But beware -- it is very difficult to understand.
14) According to our reading of the description at the above link, it turns out that, in general, the Basel Accord requires an amount equal to 8% of all loans as reserves.
15) Why the United States is obliged to follow an International accord as well as its own law on the subject of reserves is hard to understand.
16) At <<http://en.wikipedia.org/wiki/Reserve_ratio>> you will find that Australia, Canada, Mexico, New Zealand, Sweden and United Kingdom each have a no reserve requirement. In this writer's opinion, reserve requirements are an out-dated artifact carried over from the days when people thought money was backed by gold and silver. In all modern banking systems, money is created when a bank makes a loan. It seems foolish to prohibit a bank from making a loan when it has a borrower with good collateral and a sensible plan to use the borrowed money to create wealth. The downside leverage (see B-13) in the fractional reserve system is all that is needed to keep the banks prudent as long as banks are prohibited from selling their loans to third parties.
17) The following (18 and 19) is from the Wikipedia link referenced above.
18) A cash reserve ratio (or CRR) is the percentage of bank reserves to deposits and notes. The cash reserve ratio is also known as the cash asset ratio or liquidity ratio. In the United States, the Board of Governors of the Federal Reserve System requires zero percent (0%) fractional reserves from depository institutions having net transactions accounts of up to $9.3 million.[1] Depository institutions having over $9.3 million, and up to $43.9 million in net transaction accounts must have fractional reserves totaling three percent (3%) of that amount.[2] Finally, depository institutions having over $43.9 million in net transaction accounts must have fractional reserves totaling ten percent (10%) of that amount.[3] However, under current policy, these numbers do not apply to time deposits from domestic corporations, or deposits from foreign corporations or governments, called "nonpersonal time deposits" and "eurocurrency liabilities," respectively. For these account classes, the fractional reserve requirement is zero percent (0%) regardless of net account value.[4]
19) The Bank of England holds to a voluntary reserve ratio system. In 1998 the average cash reserve ratio across the entire United Kingdom banking system was 3.1%. Other countries have required reserve ratios (or RRRs) that are statutorily enforced (sourced from Lecture 8, Slide 4: Central Banking and the Money Supply, by Dr. Pinar Yesin, University of Zurich (based on 2003 survey of CBC participants at the Study Center Gerzensee[5]):
Country & Required reserve ratio
Australia -- None / Canada -- None / Mexico -- None / New Zealand -- None / Sweden -- None / United Kingdom -- None / Eurozone -- 2.00 / Slovakia -- 2.00 / Switzerland --2.50
NOTE -- In reality, Banks do not need "reserves" -- they make money out of thin air as explained at B-7 previously.
If, after reading all this, you still can't grasp the concept that our banking system does not need reserves, it probably is because you think the "reserves" were designed to protect either the system the government, the general public, the borrowers or the lender banks.
We can't figure out how the eserves protect any person or any thing. Think about this. Who is protected by the reserves? Most of us intuitively think that the reserves stop the banks from either (a) lending so much as to cause inflation or (b) running out of money to lend or use in the future. Neither is true.
In the case of (a), sensible lending can't cause inflation because all the lent money is not a permanent increase in the money supply that is unbalanced by an increase in wealth. Every sensible loan should create enough wealth to easily offset the dollar amount of the loan and/or it should be paid back by the borrower. And beside that when the money is paid back it is extinguished.
How then, you might ask, are the banks restricted from making loans that are not sensible and which will not create wealth and be paid back? The restrictions should be built into prudent banking laws and bank charters. If a given bank makes a significant amount of loans that are not paid back, the bank that makes those loans will wind up bankrupt and will thereby automatically remove itself as a bank. The public, the nation and the system needs no more protection than that. That downside leverage built into a properly run Fractional Reserve System should provide all the protection we need. If the system is run poorly, and is not followed closely by a regulatory system -- it will probably lead to significant problems and a breakdown of the system.
The recent banking problems can primarily be traced to banks not being held accountable for bad loans. They were allowed to sell off their loans to Freddie Mac and Fannie Mae and thus escape the penalties normally incurred by a lender.
In the case of (b), the bank will never run out of money to lend -- because it can create the money it needs for that purpose; see page F-4 / Problem #1 and Page F-6, the middle of the page to F-8 for a discussion.
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