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I assumed banks' reserve balances at the FED would increase with higher interest rates (less lending, more money held in reserves). However, looking at the balance sheets of major banks, the ratio of current/total assets doesn't seem to be growing after the interest rates were raised.

The broader question would be: how are increasing interest rates reflected in banks' balance sheets?

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  • $\begingroup$ Why would reserve balances at the Fed increase, rather than profit-producing investments? Also, this really isn't a personal finance question unless you are investing in banks... in which case, like any other business, you read their financial statements to see what they are investing in/spending on. Increasing interest rates will result in changes which show up there $\endgroup$
    – keshlam
    Commented Apr 1 at 20:56
  • $\begingroup$ Thank you for your response @keshlam! Why would reserve balances at the Fed increase, rather than profit-producing investments? My understanding might be off but I would assume that there’s quite a limited pool of low-risk investments that would produce a return higher than current IORB rate at 5.3%. So naturally banks would start increasing their deposits at the Fed, is that incorrect? $\endgroup$
    – A. Shultz
    Commented Apr 2 at 0:28
  • $\begingroup$ you read their financial statements to see what they are investing in/spending on. Increasing interest rates will result in changes which show up there That’s exactly what I was trying to do: 1. find out how the interest paid by the Fed shows up on the income statement and 2. see whether cash positions increase on banks’ balance sheets as they lend/invest less money. $\endgroup$
    – A. Shultz
    Commented Apr 2 at 0:31
  • $\begingroup$ Banks use reserves for fractional lending, it doesn't work the way you think. Reserves are not an investment $\endgroup$
    – littleadv
    Commented Apr 2 at 8:56
  • $\begingroup$ @littleadv yes, I have a feeling my understanding is off. Could you please correct the following reasoning chain? Fed increases IOBR -> banks are incentivized to hold more reserves at the Fed to collect the risk-free 5% return -> less reserves are available for lending. $\endgroup$
    – A. Shultz
    Commented Apr 2 at 15:06

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You do have a misunderstanding but perhaps not the one you thought. The total amount of reserves in the banking system is controlled mostly by the size of the Fed balance sheet. As you know the Fed has been gradually reducing the size of their balance sheet since Covid from over 9TN to 7.5TN now. Bank reserves have fallen from a peak of 4.3TN to 3.5 TN during that time. It’s true that an individual bank can choose to hold less cash , but it ends up in another bank as a result.

Second point : just because cash yields 5.3 doesn’t mean other assets are less attractive. For example mortgage bonds are at 5.7% today and banks certainly hold a lot. Other fixed income securities may also be held if the bank believes the Fed will cut rates.

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  • $\begingroup$ Thanks @dm63! To confirm my understanding: The total amount of reserves in the banking system is controlled mostly by the size of the Fed balance sheet. Does this mean that there's no way for banks to hold more money with the FED to capitalize on 5.3% IORB rate (unless FED purchases securities from the bank)? What about a scenario when the bank has idle cash but no attractive assets to purchase, how would the bank get the 5.3% rate if fed is reducing its balance sheet? $\endgroup$
    – A. Shultz
    Commented May 28 at 22:25
  • $\begingroup$ At least from my understanding: it sounds like a bank can deposit reserves at the FED, and the FED would have to purchase some securities to balance its assets/liabilities. However, as you mentioned, FED is currently unwinding it's balance sheet, so it seems that bank deposits should go down too. But in this case I'm not quite sure how FED is able to maintain IORB. @dm64 I'd really appreciate if you could point me to any resources that might help me understand these details. $\endgroup$
    – A. Shultz
    Commented May 28 at 23:18
  • $\begingroup$ If a bank has excess reserves, it can, by definition, obtain 5.3% from the Fed for those. i thin k you can study the fed's balance sheet over time to see what is going on: federalreserve.gov/releases/h41/20240523 $\endgroup$
    – dm63
    Commented May 29 at 1:25

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