![]() To another bank who maybe needs reserves. Reserves could be used for something else. And what could it be used for? So let's say this portion of its Reserves could be used for doing something else. Would feel comfortable being at a 15% reserve ratio. Reserve- let's say it's at a 20% reserve ratio. Lending- so it could actually- because it's This bank could do with these extra reserves. Or before the fed does anything, this bank has a littleīit extra reserves, this bank has a littleīit less reserves. Little bit more on how open market transactions help to Interest rate or the federal reserve rate is now Video is that the federal reserve- they don't say, These are all federal reserve notes, they kind of all come Separate- OK, this guy has this much- I don't know Were essentially demand accounts with the reserveīank, then we could even divide them up a little bit and So let me draw a lineįrom there to there. Reserve bank, those are of course liabilities for the And of course if these areĮither federal reserve notes or these are deposits within the ![]() Liabilities, but I've just assumed that all of them Side now so that we can compare it directly with theĭemand deposits or the liabilities of this bank. Video, I'm drawing the reserves at the top of the asset Reserve notes- and we all know that as dollars or cash. The federal reserve or these could actually be federal Is a bank with a little bit less reserves. Whole process again, just so it really sinks into yourīrain and I've drawn the banks in a different arrangement The market for structured products is alive and well and has been fully valued for quite some time now. ![]() Also, what makes you say there is no market for MBS and CDO's? There was a time in 2008/2009 when there literally wasn't a market for them, but the Fed stepped in and put a floor under it. They literally have an unlimited balance sheet. But if they have excess funds at the end of any day, the will try to lend those out to other institutions at 0.25%.Īlso, there is no solvency constraint on the Fed. Yes a bank could lend at higher than 0.25% over a longer period of time and they will do so if there are credit worthy borrowers. So, this is a pretty good deal if you're a bank with extra money at the end of the day. If the market was to determine what the shortest term interest rates were, the rates would naturally fall to 0%. But, the interest rate is 0.25%, how come? The Fed actually manipulates the fed funds rate higher. There is essentially no credit or inflation risk in an overnight loan between two banks, therefore there should also essentially be no interest on these loans. ![]() At the end of any given day, if a bank has excess funds, it will try to lend them out overnight to banks that need them. The fed funds rate determines the shortest term lending rates and the shortest term any bank will lend for is overnight. ![]() The second improves the business relations between banks because the lending bank might need a loan tomorrow if enough of its customers pull money out that day. So the risk to the lending bank is very small for the interest earned. Banks are generally some of the least risky institutions to lend to and the loans are very short term (just a day or two). In the first case they get to make some interest on money that would have otherwise been sitting there doing nothing. Loans to individuals are almost always at higher rates because the're generally more risky.īanks loan to other banks for two main reasons: they have more money laying around then they need for their reserves and as quid pro quo for business relations. When you get a variable rate loan, like a credit card or something, the rate might be specified as LIBOR plus some. An example is the LIBOR rate which is the average rates that a group of banks in London use to lend to each other. In my understanding the rate is usually lower. ![]()
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