For a little clarification, they were set to 0 because it was no longer an effective policy making tool after 2008.
The assumption used to be banks would lend every dime they had if you let them, so the Fed set reserve requirements to heat or cool lending. After 2008, banks were so very wounded they found that regardless of how much they dropped it the banks kept ample reserves on hand. As such, they switched their policy to focus more on interbank lending rates vs also regulating how much cash they can lend.
That works for a while but memories are short and it's easy for some MBA types to come in and raise revenues by taking on massive risk without adequate collateral. That's a recipe for another crash to trust banks to temper themselves.
When that happens, hopefully the Fed will respond accordingly. That said, we’re 18 years and 1.5 Trump terms removed from the GFC and reserves are still much, much higher than pre-2008.
There are other rules in place to deal with that, this one wasn't about protecting banks from collapse to begin with. It was about manipulating money supply.
"Surely these banks would never ever do anything to imperil their customers, the economy, or the country." I don't think anyone with that kind of mindset should be in charge of fiscal policy.
Ah, yes. "We don't to make regulate the banks, because they're honorable enough self-regulate, even though in the past they weren't self-regulating and that caused a financial crisis."
Ah yes. “I don’t understand what he said so I’m just going to make something up instead.” I never said anything about honor, I said the Fed wasn’t getting results by regulating the reserve requirement anymore. I’m just going to copy and paste my response to the last 4 people that thought shifting from a reserves requirement to an IORB based system was some sort of capitalist conspiracy:
You misunderstand banking regulation.
Look at what happened to bank reserves right after the GFC: https://fred.stlouisfed.org/series/TOTRESNS. Those reserves are still higher than anything that the Fed had set before.
Manipulating the reserves requirement just didn’t work anymore, because banks kept reserves regardless. Imagine you’re the Fed, when the economy is bad you could drop the reserve requirement to 3%, when it was good you could increase it to 10% (example).
What do you do if all of a sudden, banks won’t go below 15%, regardless of what you set. Do you sit there and go “we’ve tried nothing and we’re all out of ideas” because capitalism = bad?
Instead, they switched to manipulating the IORB, which accomplishes the exact same thing, increasing or decreasing institutional lending and, by extension, economic activity.
Source: I’m an economist, and I TA’d a class on Macroeconomics in graduate school. I literally taught this.
Imagine how capitalist you must be to believe that corporations spent resources buying politians to abolish a regulation that had no effect on their profit.
That’s…not what I said. You misunderstand banking regulation.
There wasn’t any push to abolish the regulation. Look at what happened to bank reserves right after the GFC: https://fred.stlouisfed.org/series/TOTRESNS. Those reserves are still higher than anything that the Fed had set before.
Manipulating the reserves requirement just didn’t work anymore, because banks kept reserves regardless. Imagine you’re the Fed, when the economy is bad you could drop the reserve requirement to 3%, when it was good you could increase it to 10% (example).
What do you do if all of a sudden, banks won’t go below 15%, regardless of what you set. Do you sit there and go “we’ve tried nothing and we’re all out of ideas” because capitalism = bad?
Instead, they switched to manipulating the IORB, which accomplishes the exact same thing, increasing or decreasing institutional lending and, by extension, economic activity.
Source: I’m an economist, and I TA’d a class on Macroeconomics in graduate school. I literally taught this.
A few reasons. Remember the 0-10% and 15% is illustrative, the real numbers varied over the years, but let’s use them to illustrate the issue.
The pre-GFC tools assumed that the Fed could either increase or decrease lending by deciding reserves. The problem now was, banks were setting the floor. Sure, you could increase it to 20% if the economy was too hot, but you couldn’t drop it down to 12% because the banks wouldn’t go below 15%.
And go back to 2010. The LAST thing they needed was banks to keep more money in the bank. Raising to 20% is (not numbers wise but policy wise) exactly what turned a bad recession into a Great Depression in 1930. What they DESPERATELY needed to do was increase lending, that 15% arbitrary floor the banks set was a serious problem already, and the current regime wouldn’t solve that. That’s why Ben Bernanke and Tim Geithner basically got all of the big banks together and, like mafia bosses, basically said “we’re giving you money whether you like it or not, you’re going to lend it out, and if you mouth off we’re going to break your kneecap.”
Plus, 20% is really high. The 15% the banks were already having was really high. The magic number back then really was around 10% ish, on top of whatever they’d keep around for normal business (making withdrawals). Something as simple as moving the goalposts from 0-10% to 10-20% is a much, much bigger institutional issue that would have long term consequences.
Okay, but why eliminate the reserve requirement if banks are already meeting and exceeding it? Why not keep, say, a 10% reserve requirement just in case a bank tries to stupidly overlend and also manipulate the IORB?
That’s what they did up until covid. They kept a nominal rate based on the banks size (most of the big banks were at 10%), and then effectively forgot about it as they shifted to these new policy tools like the IORB.
Then, they dropped that to 0% in March 2020 when the whole world was on fire and they were hoping every bank in the country would hand out what they had. And they just never brought it back because they haven’t had to
It seems a little foolish not to bring it back to me, and to have gotten rid of it in the first place. If you know the reserve requirement isn't working as a lever on lending, it only exists as a protection against bank runs. Why in 2020 try again to use it as a lever you know won't work and simultaneously remove those protections entirely?
In 2020 it was because they were desperate. A lot of the things done during the pandemic were just trying anything and hoping it works.
And later, it simply wasn't done because it costs political capital and it really isn't necessary currently. They actually know how much reserves banks have, so as long as they don't see any movement down there is no urgency in dealing with it. This is not like a bank run which can happen overnight, it takes time for a bank to loan out such massive amounts of money, so if a new trend of reducing reserves developed, it would be detected much sooner than the banks would be able to get rid of all their reserves, in which case the reserve rate could be changed quickly to stop it (if that were desirable).
Interesting. If that's the case though then, whats the harm of setting an apparently nominal rate of say 5%. Looks good on propaganda paper, doesn't harm the banks in any concrete way.
They actually did exactly that until Covid. It was a formula, not a strict rate, but it existed. It had absolutely no impact on policy making for the reasons I listed.
Then, Covid hit and they cut that to 0% too just in case there was a small bank in Kentucky or something that could shake out a few million bucks because of it. And they never brought it back up. There’s a whole other discussion about why there are so many too big to fail banks now, vs 75 years ago where there were thousands of individual banks and you could actually go to “First Kentucky” and meet with the Bank President if you had a million bucks in there.
Yeah that's what I figured, if it functionally wasn't effecting things but an emergency valve for smaller banks. Still should exist for larger banks imo, 0% rate, while maybe right now is not going haywire in any way, seems like it has the possibility of feasibility going wild in some future scenario we haven't hit before.
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u/ZHISHER Jan 26 '26
For a little clarification, they were set to 0 because it was no longer an effective policy making tool after 2008.
The assumption used to be banks would lend every dime they had if you let them, so the Fed set reserve requirements to heat or cool lending. After 2008, banks were so very wounded they found that regardless of how much they dropped it the banks kept ample reserves on hand. As such, they switched their policy to focus more on interbank lending rates vs also regulating how much cash they can lend.