On 15 March 2020, the Federal Reserves announced that it would cut its benchmark rate to near zero and that it would also reduce the reserve requirements ratio to zero percent. This is part of its efforts to bolster the economy amidst this downturn. The reserve requirements ratio was put in place to prevent bank runs, which would be damaging to financial institutions as well as households. Why would the Fed deem that it is now safe to put the reserve requirements ratio to zero? Is it no longer afraid that bank runs may occur?
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$\begingroup$ The Fed has said it will lend freely to banks, and so in effect will deal itself with the liquidity risk associated with any potential runs on banks. There is still a solvency issue, but that is a matter for FDIC and the chartering authorities rather than the Fed. $\endgroup$– HenryMar 22, 2020 at 2:33
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2 Answers
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Reserve requirements do very little to stop bank runs, and other countries abolished them years ago. Deposit insurance is the main mechanism to stop bank runs, as well as capital requirements.
answered Mar 22, 2020 at 3:02
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I believe that the Fed is more focused on saving the US economy from collapsing because of the effects of the coronavirus situation. When the Fed wants to loosen monetary policy and increase liquidity, it lowers the reserve requirements ratio which will make lending cheaper.
Lowering the reserve requirement increases the amount of money that banks have available to lend. Since the supply of money is higher, banks can charge less to lend it. Thereby more people will access to have loans at a cheaper interest in order to encourage spending. https://www.thebalance.com/reserve-requirement-3305883
With the fast-spreading coronavirus posing a dire threat to economic growth the Fed is hoping that this move will help prevent the US economy from collapsing. https://www.cnbc.com/2020/03/15/federal-reserve-cuts-rates-to-zero-and-launches-massive-700-billion-quantitative-easing-program.html
I am sure that the Fed is concerned about bank runs but it may be the case that they only have few options available to help encourage spending to prevent our economy from collapsing.
