Net Free Reserves

What are Net Free Reserves?

Net Free 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 positive number it meant that as a whole the banking system was on net holding more excess reserves at the Fed than it was borrowing from the Fed.

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 excess reserves exceeded total discount window borrowing across all banks, this difference would be net positive and was referred to as “net free reserves” because on net banks were supplying more available reserves than they were demanding to borrow. In the reverse situation, when banks were borrowing more from the Fed than the total excess reserves they were holding, the number would be negative and was referred to as “net borrowed reserves”. 

During times of financial strength, the banking system would hold plenty of reserves to meet their liquidity needs and redemption demands, and fewer banks would need to resort to backstop borrowing from the Fed’s discount window to meet their market obligations. This would lead to net free reserves as discount borrowing fell and excess bank reserves remained plentiful. Net free reserves could thus indicate an easy credit environment relative to the demand for loans and interest rates. 

Financial Crisis and The Rise of Abundant Reserves

In response to the financial crisis of 2008 and ensuing Great Recession, 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 situation persisted and created an environment where abundant excess reserves were the norm, and routinely far outstripped the Fed’s discount window lending. Measuring 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.