US Banks Are Now Actually Hoarding Funds

Following the first quantitative easing, US banks have decided it is safer (and probably more profitable) to leave around $US1 trillion of liquidity “at call” with the federal Reserve … rather than to lend it out to you (their client) who needs is right now.

This all started shortly after the Fed offered to pay the banks 0.25% to deposit money with it, from late 2008 onwards. And if the Fed is paying them $US2.5 billion each year, why wouldn’t they?

Therefore, you need to ask the question as to how effective QE2 is likely to be – given the way the banks have acted to date.

In fact, Minneapolis Fed president Narayana Kocherlakota commented last Tuesday on the Fed’s latest easing, given the banks’ hoarding: “ I can’t see why they would suddenly start to use their current (licenses) if they aren’t using their old ones.”

The idea behind the 0.25% was to allow the Fed to exert some influence over market interest rates – quite separately from the level of reserves held under its liquidity facilities.

However, this has to be a two-way street.

Sure, some funds need to be held in reserve for safety reasons. But not to the point where the banks are actually choking off a much-needed liquidity to the US economy to build up some steam.

Therefore it would seem to make more sense to adjust this 0.25% figure, to encourage the banks to release the liquidity already available. Rather than grant a further $US600 billion to the banks – only to have them squirrel it away AND be paid by the Fed to do so.

Tags: lack of liquidity, QE2, quantitative easing, US banks