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Thank you a lot. A few further questions.

The marginal cost for the bank of making a loan is basically the funding rate - aside from the need to obtain regulatory reserves, there is no direct cost to the bank. However, running a bank involves costs, and revenue must cover those costs.
But are those running costs so high that they are comparable to a fat % of the portfolio, in properly run economies? I see only own real estate upgrades as comparably substantial costs.

This liquidity ratio is not the same as fractional reserve ratio, right?

Yes it is. Or, depending on how you define the fractional reserve ratio, it may be the inverse,

Wikipedia says somewhat otherwise:

In the United States the required reserves, also called the liquidity ratio, is set by the Board of Governors of the Federal Reserve System. Requirements vary based upon the size (in total amount of transactions) of the depository institution. For institutions with up to $10.7 million, there is no minimum reserve requirement. Institutions with over $10.7 million and up to $55.2 million in net transaction accounts must have a liquidity ratio of three percent. Institutions with more than $55.2 million in net transactions must have a liquidity ratio of 10%.

These requirements apply only to transaction accounts such as checking accounts (collectively called M1 transactions in the analysis of money supply), and do not apply to time deposits such as CDs, savings accounts, or deposits from foreign corporations or governments. For these account classes, the fractional reserve requirement is one percent (1%) regardless of net account value. When a bank falls below its reserve requirement, it can take out a very short-term loan (often for a period of 24 hours of fewer) from the Federal Reserve or from another bank with excess reserves.

What is then the difference between liquidity and solvency? For any other business entities, the liquidity ratio is just the quotient Liquid assets / Total assets.

And of course, if our bank has excess reserves, it has to borrow from the CB (even) less if at all.

Yes, but that doesn't matter, because the bank can lend excess reserves either on the interbank market or directly to the CB. And the CB always makes sure that one of those two options would pay the policy rate. Because that's what CBs do.

So, consumers have to pay to compete with the lending excess reserves option. Does this mean that the banks automatically get the CB rate gains of the liquidity reserves? Or does, in effect, the CB claims that rate out of all M1 circulation? Do the CB assets increase at all times?

by das monde on Fri May 20th, 2011 at 03:32:26 AM EST
[ Parent ]
What is then the difference between liquidity and solvency?
Solvency is the abstract quality of being able to use one's assets to meet one's liabilities. Solvency is in principle, assuming the book value of an asset allows it to be used in payment of the liabilities.

Liquidity is the ability to use an asset for payment of momentarily maturing liabilities, or more narrowly the ability to liquidate the asset for cash with which to pay the liabilities.

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Fri May 20th, 2011 at 05:21:28 AM EST
[ Parent ]
But are those running costs so high that they are comparable to a fat % of the portfolio

Well, profits alone is a cost that can't go much below half a percent of the portfolio: 5 % return on equity is not outrageous, and you don't want banks to be gearing harder than about 10 or 20 to 1 in the ordinary case.

Wikipedia says somewhat otherwise

No, it says the same thing.

So, consumers have to pay to compete with the lending excess reserves option.

Yes.

Does this mean that the banks automatically get the CB rate gains of the liquidity reserves?

Yes, any excess liquidity will be remunerated at the policy rate.

Do the CB assets increase at all times?

Yes, if the CB is doing its job right, its balance sheet should continually increase.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri May 20th, 2011 at 08:32:45 AM EST
[ Parent ]

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