Net Borrowed Reserves

What are Net Borrowed Reserves?

Net Borrowed Reserves was one side of a statistic that was (until 2013) released in weekly Federal Reserve data showing the difference between the excess reserves banks held on account at the Fed and the liquid reserves the banks had borrowed from the Fed. When this difference (excess reserves—borrowings) was a negative number it meant that as a whole the banking system was on net borrowing from the Fed more than it was lending to the Fed (by maintaining excess reserve deposits). 

Understanding Net Borrowed Reserves

In the past, deposit banks were required to keep a certain amount of reserves on hand at all times, in cash or deposits at their Federal Reserve regional branch. Any amount in excess on this minimum was in effect a short term loan to the Fed in the same sense that bank deposits that consumers and businesses hold in their bank accounts are a short term loan to the bank.

On the other hand, if banks didn’t have enough liquid reserves to meet the minimum (or other liquidity needs), they could borrow directly from the Federal Reserve, in its function as lender -of-last-resort, through the discount window.

The difference between these two amounts (the amount of excess reserves held by banks and the total borrowing from the Fed lending programs) would indicate in a sense whether banks were on net lending to or borrowing from the Federal Reserve System. When total borrowing from the Fed exceeded total excess reserves across all banks, this number would be net negative and was referred to as “net borrowed reserves” because on net banks were borrowing more from the Fed. In the reverse situation, when banks were holding more excess reserves in total than the amount banks were borrowing from the Fed, the number would be positive and was referred to as “net free reserves”. 

During times of financial stress, banks would face pressure on their reserves due to liquidity needs and redemption demands, and more banks would need to resort to backstop borrowing from the Fed’s discount window to avoid defaulting on their market obligations. This would lead to net borrowed reserves as discount borrowing rose and excess bank reserves fell. Net borrowed reserves could thus indicate a tight credit environment relative to the demand for loans and rising interest rates. 

Financial Crisis and The End of Net Borrowed Reserves

During the financial crisis of 2008 and ensuing Great Recession, the Fed rolled out numerous emergency measures and lent enormous sums to banks and other financial institutions in an effort to stabilize the financial sector. Bank borrowing from the Fed skyrocketed far above excess reserves during 2008 creating record levels of net borrowed reserves which reached -$136 billion by October 2008. 

In the fall of 2008, the Fed for the first time began paying interest to banks on their excess reserves held at the Fed. This gave banks an incentive to hold (and receive interest payments for) more excess reserves, especially given the extreme levels of risk and uncertainty in lending to the market. At the same time, because of the enormous injections of reserves that the Fed was engaging in through its various novel credit facilities and quantitative easing, banks were awash in new reserves. 

As a result, excess reserves exploded in the fall of 2008, quickly exceeding total discount borrowing by hundreds of billions, and then trillions, of dollars, resulting in unprecedented levels of net free reserves. In succeeding years, this created an environment where abundant excess reserves were the norm, and routinely far outstripped the Fed’s discount window lending. Measure net borrowed or net free reserves became less useful as an indicator of stress in the financial system, given the new monetary policy environment, and collection of this statistic ended in 2013.