You say: "Can banks buy bonds or equities with reserves? Yes, they can". Shouldn't this answer be no, but instead their other assets are reallocated? In other words, if banks can buy selected stocks with reserves, how does the seller of the stock receive their funds if reserves are not legal tender? I'm not understanding how "reallocation" can convert "reserves" into stocks, unless the reserves get outside the system somehow.
Fed QE transactions are not limited to bank counterparties, so there is also a path for QE to add commercial bank deposits:
"When the Fed purchases a financial asset, it pays for it by creating bank reserves. Nonbanks cannot hold reserves because they do not have an account at the Fed. When the Fed purchases a financial asset from a nonbank investor, the Fed sends the payment as reserves to the investor’s commercial bank. The commercial bank then credits the investor’s bank account. In this instance, the commercial bank is acting as an intermediary between the Fed and the investor since the investor is unable to hold reserves. The Fed’s action of purchasing assets increases the level of central bank reserves in the system as well as commercial bank deposits."
Ok, commercial banks swap their bonds for reserves, but, why do they do so? The article discusses what happens afterwards but not why banks agree to the QE in the first place.
I read through the comments and I feel like I am in the twilight zone. Everyone asks the same question I have, no one seems to answer it, but everyone is thanking everyone for clearing things up!!!! The question I can't find the answer to in this thread is: If reserves aren't money how can they be used to buy stocks and bonds? If a commercial bank tries to buy a bond from me I will say hell no, I can't spend your stinking reserves. If on the other hand, they buy from another commercial bank, it's just a bunch of incestuous shuffling of bonds among banks having no effect on the economy. PLEASE CLARIFY. I am begging here.
I have two questions (some overlap with questions in the chat).
1. Why do banks sell their bonds to the central banks in the first place, if its better for them to hold bonds instead of reserves? How can they be forced?
2. How exactly do HQLA help with interest rate risk hedging? Because they bring more yield or are there other reasons?
Great article Alf. The only part I don’t understand is also how the commercial banks get “forced” into the swap? Is it a matter of the bonds being on the market and the central bank just buying them all up at any price?
Why don't (or do) reserves get exchanged at some kind of discount since they are not fully fungible with "regular" dollars? Also, what is the mechanism for forcing commercial banks to participate in QE? Regulatory mandate?
Alf great stuff. Question - "They start buying the very same bonds QE is buying". Can banks use their new reserves asset at the Central Bank to buy Treasuries? Or must they use normal cash?
Thanks Alf. This is a difficult topic for me but you explained it so well and concisely. P.s., I am also a goalkeeper 🧤⚽️ (I recall you mentioning that in the talk with Hugh) 😊
"When a Central Bank performs QE and directly buys bonds from a commercial bank, they merely change the composition of the commercial bank asset side" ⬅ But as a private citizen, my bond portfolio has just increased in value, which I can then sell and receive more bank "deposits" for those bonds than I could before QE. So surely QE does indirectly result in more bank deposits being created, as long as people who just got richer from their bond portfolio decide to cash out some of their gains?
Great piece. Curious doesn’t an increase in bank reserve naturally enable the bank to issue larger credits per Basel III? Assume bank had 10x reserve ratio with 1 dollar in reserve and 10 dollars in credit, enlarging its reserve to 2 dollars certainly can double its credits?
So I assume QT means banks will need to reverse this process and increase holdings of reserves, since their bond holdings will be skewed to the upside as reserves are pulled from the system by the Fed? Also how would the recent rout in the bond/equity markets affect banks allocation to HQLA's? I guess increasing volatility means they would reduce exposure to corporate debt and move to treasury's?
Thank you, this is educational. How did they expect QE to increase inflation if most of the buyers of risk assets are a small proportion of the population, and their extra capital usually goes to equities and other real assets? Until recently, QE really only succeeded in raising prices of stocks and houses.
You say: "Can banks buy bonds or equities with reserves? Yes, they can". Shouldn't this answer be no, but instead their other assets are reallocated? In other words, if banks can buy selected stocks with reserves, how does the seller of the stock receive their funds if reserves are not legal tender? I'm not understanding how "reallocation" can convert "reserves" into stocks, unless the reserves get outside the system somehow.
Fed QE transactions are not limited to bank counterparties, so there is also a path for QE to add commercial bank deposits:
"When the Fed purchases a financial asset, it pays for it by creating bank reserves. Nonbanks cannot hold reserves because they do not have an account at the Fed. When the Fed purchases a financial asset from a nonbank investor, the Fed sends the payment as reserves to the investor’s commercial bank. The commercial bank then credits the investor’s bank account. In this instance, the commercial bank is acting as an intermediary between the Fed and the investor since the investor is unable to hold reserves. The Fed’s action of purchasing assets increases the level of central bank reserves in the system as well as commercial bank deposits."
- Wang, Joseph J. Central Banking 101 (p. 39)
Ok, commercial banks swap their bonds for reserves, but, why do they do so? The article discusses what happens afterwards but not why banks agree to the QE in the first place.
I read through the comments and I feel like I am in the twilight zone. Everyone asks the same question I have, no one seems to answer it, but everyone is thanking everyone for clearing things up!!!! The question I can't find the answer to in this thread is: If reserves aren't money how can they be used to buy stocks and bonds? If a commercial bank tries to buy a bond from me I will say hell no, I can't spend your stinking reserves. If on the other hand, they buy from another commercial bank, it's just a bunch of incestuous shuffling of bonds among banks having no effect on the economy. PLEASE CLARIFY. I am begging here.
Very interesting, Mr. Alf. Can you please explain how a bank uses reserves to purchase treasuries, corporate bonds, and certain stocks?
Great article, thanks Alf!
I have two questions (some overlap with questions in the chat).
1. Why do banks sell their bonds to the central banks in the first place, if its better for them to hold bonds instead of reserves? How can they be forced?
2. How exactly do HQLA help with interest rate risk hedging? Because they bring more yield or are there other reasons?
Great article Alf. The only part I don’t understand is also how the commercial banks get “forced” into the swap? Is it a matter of the bonds being on the market and the central bank just buying them all up at any price?
Why don't (or do) reserves get exchanged at some kind of discount since they are not fully fungible with "regular" dollars? Also, what is the mechanism for forcing commercial banks to participate in QE? Regulatory mandate?
Alf great stuff. Question - "They start buying the very same bonds QE is buying". Can banks use their new reserves asset at the Central Bank to buy Treasuries? Or must they use normal cash?
Thanks Alf. I truly appreciate you breaking these things down the way you do. Much appreciated.
Thanks Alf. This is a difficult topic for me but you explained it so well and concisely. P.s., I am also a goalkeeper 🧤⚽️ (I recall you mentioning that in the talk with Hugh) 😊
"When a Central Bank performs QE and directly buys bonds from a commercial bank, they merely change the composition of the commercial bank asset side" ⬅ But as a private citizen, my bond portfolio has just increased in value, which I can then sell and receive more bank "deposits" for those bonds than I could before QE. So surely QE does indirectly result in more bank deposits being created, as long as people who just got richer from their bond portfolio decide to cash out some of their gains?
Great piece. Curious doesn’t an increase in bank reserve naturally enable the bank to issue larger credits per Basel III? Assume bank had 10x reserve ratio with 1 dollar in reserve and 10 dollars in credit, enlarging its reserve to 2 dollars certainly can double its credits?
So I assume QT means banks will need to reverse this process and increase holdings of reserves, since their bond holdings will be skewed to the upside as reserves are pulled from the system by the Fed? Also how would the recent rout in the bond/equity markets affect banks allocation to HQLA's? I guess increasing volatility means they would reduce exposure to corporate debt and move to treasury's?
Thank you, this is educational. How did they expect QE to increase inflation if most of the buyers of risk assets are a small proportion of the population, and their extra capital usually goes to equities and other real assets? Until recently, QE really only succeeded in raising prices of stocks and houses.
I am a better version of myself than yesterday. Thanks.