Economic Peekaboo: Plunging Bank Reserves Unveil Potential Upswing?
By Vaughn Woods, CFP, MBA
The New York Federal Reserve Bank recently noted in an article entitled “Dropping Like a Stone,” that the reserve requirement for banks is dropping. This is good for bank profits and borrowers. The steady decrease in reserve requirements follows a rapid increase from close to zero in early 2021 to $2.2 trillion in December 2022, and a period of relatively stable balances during the first half of 2023.
Looking back, the required increase in bank reserves took place between 2021 and May of 2023. This increase was driven by the uncertainty of the pandemic, rapid rate hikes to fight inflation, the resulting increase in interest-rate uncertainty and the decrease in the T-bill supply between 2021-2022.
After March of 2023 the ratio of bank reserves to assets began to decline, the pace of interest-rate hikes slowed down and the supply of T-bills for sale increased again. If these dynamics persist in the months ahead the sum of money available to loan out to the public will grow, increasing bank profitability. Such a steady decline would be similar to the decline observed in early 2018 when reserves in the banking system became less abundant.
Reducing the requirement for excess reserves also makes banks more profitable since the very cost of managing excess reserves requires sophisticated technology and software. While the cost of labor may not go up, the sum of time required to manage these excess reserves as rates fluctuate upward can potentially impact the profitability of the bank. Moreover, resources tied up in reserves are not available for lending or other investments, potentially impacting resource allocation within the bank.
If you combine the complex phenomena of declining inflation, lower rates, improving bank profitability, and greater access to bank loans as excess reserve requirements decline, several elements of optimism arise. Greater access to credit, lower weighted average cost of capital for corporations, increased housing market activity, increased consumer spending, positive market sentiment, boosted investment in debt instruments, reduced uncertainty, making spending decisions with greater confidence, and potentially higher stock prices…though I expect the second half of 2024 to be more productive as there remains some technical risk over a March rate cut disappointment.
Thank you for your referrals,
Vaughn L. Woods, CFP, MBA
Vaughn Woods Financial Group, Inc.
2226 Avenida De La Playa
La Jolla, CA 92037
858-454-6900
Investors should be aware that there are risks inherent in all investments such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter are those of Vaughn Woods and Vaughn Woods Financial Group and may not reflect the views of Bolton Global Capital or Bolton Global Asset Management. The information provided is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0xxx.
Newyorkfed.org