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Excess reserves

Excess reserves refer to the funds held by depository institutions at the Federal Reserve in excess of the reserve balance requirements imposed by the central bank.^[1] These reserves arise when banks maintain balances beyond the mandated minimums, typically to manage liquidity needs or in response to monetary policy incentives such as interest payments on those balances.^[2] Historically, excess reserves in the U.S. banking system remained low, often in the range of a few billion dollars, as banks faced an opportunity cost to holding idle funds without remuneration, preferring to lend them out in the federal funds market.^[3] This dynamic supported the traditional money multiplier model, where reserve scarcity influenced lending and money supply expansion.^[4] Following the 2008 financial crisis, however, the Federal Reserve's implementation of quantitative easing programs and the introduction of interest on excess reserves in October 2008 dramatically altered this landscape.^[5] Excess reserves surged from approximately $2 billion pre-crisis to peaks exceeding $2.5 trillion by 2014, as the Fed expanded its balance sheet through asset purchases and provided incentives for banks to retain liquidity amid heightened uncertainty and credit risks.^[3]^[6] In the post-crisis "ample reserves" regime, excess reserves have facilitated a shift in monetary policy implementation from managing reserve scarcity to setting administered rates, primarily the interest rate on reserve balances (IORB), which influences short-term market rates without relying on open market operations to drain liquidity.^[7] This framework enhances the Fed's ability to respond to economic shocks by maintaining ample liquidity buffers, though it has raised questions about potential distortions in credit allocation and the efficiency of the banking system, as large reserve holdings may reduce incentives for productive lending.^[8] Empirical evidence indicates that while excess reserves peaked during quantitative easing, subsequent balance sheet normalization efforts, including quantitative tightening since 2022, have reduced them to around $3 trillion as of 2023, yet they remain substantially above pre-crisis levels.^[6]

Fundamentals

Definition and Calculation

Excess reserves are the reserves held by depository institutions beyond the minimum amounts required by the central bank's regulations. In the United States, these consist of balances maintained at Federal Reserve Banks plus vault cash that exceed the reserve balance requirements specified under Regulation D.^[9]^[10] Excess reserves for an individual institution are calculated by subtracting required reserves from total reserves. Total reserves equal the sum of reserve balances at the Federal Reserve and eligible vault cash. Required reserves are computed by multiplying the applicable reserve requirement ratios—historically tiered from 0% to 14% based on net transaction account balances as of the reserve computation period—by the institution's reservable liabilities, primarily net transaction accounts, nonpersonal time deposits, and Eurocurrency liabilities.^[10]^[9] The formula is expressed as:

\text{Excess Reserves} = \text{Total Reserves} - \text{Required Reserves}

where \text{Required Reserves} = \sum (r_i \times L_i), with r_i as the reserve ratio for each category of liabilities L_i. Aggregate excess reserves across the banking system are reported weekly by the Federal Reserve based on data from depository institutions' reserve maintenance periods, which run from Thursday to Wednesday.^[9]^[10] Note that effective March 26, 2020, the Federal Reserve reduced all reserve requirement ratios to 0%, rendering required reserves zero and equating excess reserves to total reserves system-wide.^[10]

Role in Banking and Monetary Systems

Excess reserves function as a precautionary liquidity buffer for depository institutions, allowing banks to absorb unanticipated deposit withdrawals, settle interbank payments, or comply with intraday liquidity demands without immediate need to liquidate assets or borrow at potentially elevated market rates. This role enhances financial stability by providing readily available funds at the central bank, which serve as the safest and most liquid asset in the banking system, thereby reducing systemic liquidity risks during normal operations or mild stresses. Empirical evidence from the U.S. banking system indicates that banks voluntarily hold excess reserves to manage operational risks, with holdings fluctuating based on opportunity costs relative to returns on alternative assets like loans or securities.^[2]^[7]^[11] In the broader monetary system, excess reserves modulate the transmission of central bank policy by influencing short-term interest rates and the pace of credit creation. Under an ample-reserves framework, as implemented by the Federal Reserve post-2008, banks maintain large excess balances, which diminish the demand for interbank lending and anchor the federal funds rate near the interest rate on reserve balances (IORB), set by the central bank to establish a policy floor without requiring reserve drainage. This mechanism decouples monetary policy from traditional reserve scarcity, enabling control over money market rates while accommodating payment system growth; however, elevated excess reserves suppress the money multiplier, as institutions prioritize holding non-interest-bearing or low-yield reserves over extending loans, resulting in muted expansion of broader money supply measures like M2 relative to the monetary base. For instance, the U.S. money multiplier fell sharply from around 9 in 2008 to below 4 by 2010 amid surging excess reserves, reflecting banks' reduced propensity to multiply deposits through lending.^[12]^[13]^[14]

Historical Context

Pre-2008 Low-Reserves Regime

Prior to the 2007-2008 financial crisis, the U.S. banking system operated under a low-reserves regime characterized by minimal excess reserves held by depository institutions. Excess reserves, defined as reserves beyond those required by Federal Reserve regulations, averaged approximately $1.9 billion in 2007, compared to required reserves of $43 billion.^[15] This scarcity persisted throughout the preceding decades, with system-wide excess reserves typically fluctuating between $1.5 billion and $2 billion daily to meet precautionary demands, particularly from smaller banks with limited access to interbank funding markets.^[16] The Federal Reserve maintained this environment by supplying a limited quantity of reserves through open market operations, ensuring the federal funds rate aligned closely with its target without flooding the system.^[17] In this regime, the absence of interest payments on reserves created a strong incentive for banks to minimize excess holdings, as idle reserves earned no return and represented an opportunity cost relative to lending or investing elsewhere.^[18] Banks actively managed liquidity through the federal funds market, borrowing and lending reserves overnight to meet reserve requirements and avoid penalties for shortfalls.^[19] The Federal Reserve influenced short-term interest rates by adjusting the supply of reserves via daily open market operations, targeting a corridor bounded by the discount rate above and zero below, though in practice, rates rarely approached the extremes due to efficient market functioning.^[1] This framework supported a relatively predictable transmission of monetary policy, where changes in the monetary base could influence broader money supply through bank lending, albeit with empirical deviations from textbook multiplier predictions due to varying credit demand and regulatory factors. The low-reserves environment reinforced reserve-constrained banking behavior, encouraging institutions to expand loans and deposits to maximize returns on capital.^[20] Reserve requirements, set at 10% for transaction accounts over a certain threshold and lower for non-transaction liabilities since reductions in 1990 and 1992, bound active reserve management without significant buffers.^[10] Consequently, excess reserves remained negligible as a share of total deposits, typically under 0.1%, fostering a system where interbank liquidity allocation played a central role in daily operations and monetary control.^[21] This pre-crisis setup contrasted sharply with post-2008 developments, highlighting the role of policy incentives in shaping reserve demand.

Post-2008 Surge from Crisis Response

![Federal Reserve excess reserves, 1984-2019]float-right The 2008 financial crisis prompted the Federal Reserve to implement extraordinary measures that dramatically increased excess reserves in the U.S. banking system. Following the Lehman Brothers bankruptcy on September 15, 2008, the Fed expanded emergency lending facilities and conducted large-scale open market operations to inject liquidity and stabilize financial markets.^[22] These actions caused total reserves to rise sharply from approximately $40 billion in mid-2008.^[23] On October 6, 2008, the Federal Reserve announced it would begin paying interest on required and excess reserve balances, effective retroactively from October 1, to encourage banks to hold reserves rather than lend them out amid heightened uncertainty.^[24] This policy, authorized by the Emergency Economic Stabilization Act, set the interest rate on excess reserves (IOER) initially at 75 basis points below the federal funds target, providing a floor for short-term interest rates.^[25] Excess reserves, which averaged $1.9 billion in August 2008, began accumulating as banks preferred the risk-free return from IOER over uncertain lending opportunities.^[20] ^[15] The surge intensified with the initiation of quantitative easing (QE). QE1, announced on November 25, 2008, involved purchasing up to $500 billion in mortgage-backed securities (MBS) and agency debt, later expanded to $1.25 trillion in MBS and $175 billion in agency debt by March 2010.^[26] These asset purchases directly credited bank reserve accounts at the Fed, expanding the monetary base and excess reserves. By January 2015, excess reserves had reached $2.6 trillion, reflecting the Fed's balance sheet growth from under $1 trillion pre-crisis to over $4 trillion.^[20] ^[27] This reserve accumulation stemmed from the Fed's dual mandate to support financial stability and employment during the recession, where traditional interest rate cuts to near-zero proved insufficient. Banks' reluctance to expand loans, due to balance sheet repair and regulatory pressures post-crisis, further contributed to reserves remaining excess rather than fueling credit multiplication.^[5] The policy shift marked a departure from the pre-2008 scarce reserves regime, establishing an "ample reserves" framework that persisted into subsequent years.^[6]

Policy Mechanisms

Interest on Excess Reserves in the US

The Federal Reserve began paying interest on excess reserves (IOER) on October 6, 2008, as a tool to maintain control over short-term interest rates amid the expansion of its balance sheet during the financial crisis.^[15] This authority stemmed from the Financial Services Regulatory Relief Act of 2006, which permitted the Fed to pay interest on both required and excess reserves starting October 1, 2011, but Congress and the Fed accelerated implementation via the Emergency Economic Stabilization Act of 2008 to address liquidity pressures without driving the federal funds rate to zero.^[24] Initially set at 0.75% for excess reserves (10 basis points below the then 1.00% federal funds target for required reserves), the IOER rate has since been adjusted by the Federal Open Market Committee (FOMC) to align with policy targets.^[28] IOER functions as a policy floor for the federal funds rate by providing banks with a risk-free return on unlent reserves held at the Fed, discouraging interbank lending below that level unless market conditions warrant it.^[29] In the post-2008 ample reserves regime, where reserve balances far exceed required levels due to quantitative easing, the Fed relies on IOER—now unified with interest on required reserves as the interest on reserve balances (IORB) rate effective July 29, 2021—to steer the effective federal funds rate (EFFR) within its target range.^[2]^[30] The IORB rate is set administratively by the Board of Governors, typically at or near the top of the FOMC's federal funds target range, complemented by the overnight reverse repurchase agreement (ON RRP) facility rate as a supplementary floor for non-depository institutions.^[12] This framework replaced the pre-2008 scarce reserves system, where open market operations directly managed reserve scarcity to influence rates. Empirical evidence indicates IOER has effectively anchored the EFFR, with spreads between the EFFR and IOER narrowing to 5-10 basis points in recent years, even as reserves declined from peak levels above $3 trillion in 2014.^[31] Critics argue it incentivizes banks to hold reserves rather than extend credit, potentially distorting lending, though studies show limited aggregate impact on loan growth when controlling for economic conditions.^[30] The mechanism's success relies on ample reserves; as the Fed reduces its balance sheet via quantitative tightening, ongoing monitoring of reserve demand ensures the floor system remains viable without reverting to corridor-style policy.^[32] As of October 2025, the IORB rate continues to serve as the primary lever for transmission of FOMC rate decisions to broader money markets.^[12]

Quantitative Easing and Reserve Creation

![Federal Reserve excess reserves 1984-2019][float-right] Quantitative easing (QE) entails a central bank purchasing large quantities of financial assets, such as government bonds and mortgage-backed securities, from commercial banks and primary dealers. The Federal Reserve finances these purchases by crediting the reserve accounts of the selling institutions with newly created electronic reserves, thereby expanding the monetary base and generating excess reserves in the banking system.^[33]^[34] This process directly injects liquidity without relying on traditional open market operations tied to short-term interest rates. In the United States, the Federal Reserve initiated QE in response to the 2008 financial crisis. QE1 began in November 2008 with purchases of up to $600 billion in mortgage-backed securities, later expanded to $1.75 trillion including agency debt and Treasury securities by March 2010. QE2, announced in November 2010, involved $600 billion in longer-term Treasury securities purchased by June 2011. QE3, starting in September 2012, committed to $40 billion monthly in agency mortgage-backed securities, increased to $85 billion in December 2012 including Treasuries, continuing until tapering in late 2013 and ending asset purchases in October 2014. These programs expanded the Fed's balance sheet from about $900 billion pre-crisis to over $4.5 trillion by 2014, with bank reserves rising from under $10 billion in 2007 to approximately $2.7 trillion in 2014, predominantly as excess reserves.^[33]^[35]^[6] The creation of excess reserves through QE decoupled reserve levels from lending activity, as banks held these balances at the Fed rather than extending credit, influenced by factors including the 2008 introduction of interest on excess reserves. This mechanism aimed to lower long-term interest rates and support financial market functioning, though empirical outcomes on broad money supply and inflation diverged from pre-QE textbook money multiplier expectations.^[36]^[26]^[6]

Economic Effects

Impact on Inflation Dynamics

In conventional monetary theory, an expansion of excess reserves is anticipated to stimulate bank lending, thereby increasing the money supply and exerting upward pressure on inflation through the money multiplier mechanism.^[6] However, empirical observations following the 2008 financial crisis deviated from this expectation, as the U.S. monetary base expanded dramatically without corresponding inflationary surges.^[37] From August 2008, when excess reserves stood at approximately $1.8 billion, they escalated to over $2.7 trillion by early 2015 amid quantitative easing programs, yet consumer price index (CPI) inflation averaged below 2% annually through 2019.^[38] ^[39] This disconnect arose primarily because banks opted to hold reserves rather than extend loans, disrupting the traditional transmission from reserves to broader money and prices.^[20] The Federal Reserve's implementation of interest on excess reserves (IOER), effective October 2008 at 0.25%, played a pivotal role in this dynamic by providing banks a risk-free return comparable to or exceeding yields on alternative assets, thereby establishing a floor for short-term interest rates and curbing excess lending.^[37] ^[40] As a result, the IOER mechanism enabled the Fed to conduct large-scale asset purchases without immediate inflationary consequences, altering inflation dynamics to depend more on the sterilization of reserves via remunerated holdings than on reserve quantities alone.^[29] Post-2020, amid further reserve accumulation to $3.2 trillion by May 2020, inflation remained dormant until fiscal stimulus and supply disruptions in 2021 propelled CPI to 7% by year-end, underscoring that excess reserves alone do not drive inflation absent velocity increases or credit expansion.^[39] This evidence highlights a regime shift where central bank remuneration of reserves decouples monetary base growth from price stability, allowing policy flexibility but raising questions about long-term risks if IOER adjustments fail to contain potential reserve outflows.^[6]

Effects on Lending and Credit Allocation

The payment of interest on excess reserves (IOER) by the Federal Reserve establishes a risk-free return benchmark that influences banks' lending decisions, as institutions compare it against the expected yields from loans net of credit and operational risks.^[29] Banks are incentivized to hold reserves when IOER exceeds the marginal return on new loans, effectively raising the floor for lending rates and reducing the volume of credit extended to borrowers.^[30] This mechanism decoupled reserve levels from lending activity post-2008, as the traditional money multiplier framework—where reserve expansion proportionally boosts deposits and loans—ceased to hold empirically.^[6] Empirical analyses confirm that elevated excess reserves, sustained by IOER and quantitative easing, suppressed bank lending growth. From August 2008 to January 2015, U.S. excess reserves expanded from $1.9 billion to $2.6 trillion, yet commercial bank lending to the private nonfinancial sector grew at subdued rates averaging under 5% annually, far below pre-crisis norms, amid banks' deleveraging and heightened risk aversion.^[20] Econometric studies indicate that IOER policy reduced aggregate lending by creating a portfolio substitution effect, with banks favoring reserves over riskier assets; for instance, a one-standard-deviation increase in reserves was associated with lower lending spreads (loan rates relative to risk-free rates), signaling compressed incentives for credit expansion.^[41] Two-stage regression estimates further link reserve premiums—implicit yields on reserves above market rates—to a 5.1% decline in bank-level lending volumes, equating to hundreds of billions in foregone credit.^[42] Regarding credit allocation, excess reserves distort resource flows by channeling bank funds toward safer, liquid assets like U.S. Treasuries rather than productive private-sector investments, potentially exacerbating sectoral imbalances.^[43] Post-crisis data show banks increased holdings of government securities by over 200% from 2008 to 2014 while private credit outstanding stagnated, reflecting a shift to lower-risk portfolios incentivized by IOER's stability amid uncertain loan demand and regulatory pressures like Basel III capital requirements.^[44] This reallocation may have prolonged economic recovery in capital-intensive sectors, as empirical models reveal IOER's role in regime shifts where banks prioritize reserve accumulation over diversified lending, reducing credit availability to small businesses and higher-risk borrowers.^[45] Critics, including analyses from Federal Reserve research, argue this outcome aligns with causal evidence of IOER acting as a monetary policy tool separate from credit policy, though it risks entrenching inefficiencies if prolonged.^[30]^[29]

Controversies and Debates

Theoretical vs. Empirical Outcomes on Money Multiplier

In the standard textbook model of fractional reserve banking, the money multiplier mechanism predicts that an injection of reserves by the central bank expands the money supply through iterative lending: banks retain required reserves and lend the excess, which becomes new deposits subject to the same process. With a uniform reserve requirement of 10% on transaction deposits prior to 2020, the theoretical multiplier for demand deposits approximates 10, assuming no currency leakage, zero excess reserves, and ample loan demand.^[46] This exogenous view posits reserves as the binding constraint on money creation, with the Federal Reserve controlling broad money via the monetary base. Empirical outcomes diverged sharply after the 2008 financial crisis. The Federal Reserve's quantitative easing expanded the monetary base from $825 billion in August 2008 to $4.0 trillion by December 2014, predominantly through excess reserve creation, yet broad money measures like M2 grew only modestly at an average annual rate of 6.1% from 2008 to 2014, far below theoretical expectations of multiplication.^[6] The M1 money multiplier, calculated as M1 divided by the monetary base, declined from 1.66 in mid-2008 to a low of 0.82 by January 2012 before stabilizing around 1.2 by 2019.^[47] ^[48] This collapse reflected banks' accumulation of $2.4 trillion in excess reserves by 2014, rather than deploying them for lending, undermining the multiplier's predictive power.^[49] The divergence stems from the ample reserves regime established post-2008, where the October 2008 authorization of interest on excess reserves (IOER), initially at 0.25% rising to 1.0% by 2015, raised the return on reserves relative to lending amid heightened risk aversion and weak credit demand.^[50] Banks minimized lending not due to reserve scarcity but because IOER provided a risk-free yield, equivalent to a floor for the federal funds rate, while post-crisis regulations like Dodd-Frank and Basel III elevated liquidity coverage requirements, further incentivizing reserve hoarding over credit extension.^[14] Empirical analyses attribute the persistent low multiplier to subdued deposit growth from limited loan expansion and the structural shift away from reserve-constrained banking, validating endogenous money theories where lending precedes reserve acquisition.^[51]^[46]

Moral Hazard and Distortions in Banking

Excess reserves, amassed through central bank asset purchases and interest payments on reserves, can foster moral hazard by diminishing the perceived costs of liquidity shortfalls for banks, thereby encouraging riskier asset holdings and lending practices under the expectation of central bank intervention.^[52] This dynamic arises as banks, insulated by ample central bank liquidity, face reduced incentives to maintain stringent internal liquidity management or interbank monitoring, knowing that systemic support mitigates downside risks.^[53] Empirical observations from quantitative easing episodes, such as QE II (2008–2011) where reserves expanded by approximately $1.94 trillion, illustrate how such provisions correlate with banks issuing additional short-term liquidity claims, offsetting net liquidity gains and amplifying reliance on central bank backstops.^[52] In the interbank market, collective moral hazard intensifies with excess reserves, as interconnected banks exploit implicit guarantees to channel funds toward high-risk projects, socializing potential losses while privatizing gains.^[53] Models demonstrate that this leads to inefficient risk-sharing, where smaller banks hold liabilities of systemically important institutions, elevating overall systemic volatility without corresponding prudential oversight.^[53] During the post-2008 period, U.S. excess reserves peaked at over $2.7 trillion by late 2014, coinciding with diminished interbank lending scrutiny, as evidenced by elevated interbank rates despite reserve abundance when hoarding by healthy banks withheld liquidity from stressed counterparts.^[52]^[54] Distortions manifest in credit allocation, where banks prioritize holding reserves—yielding returns comparable to loans via interest on excess reserves (IOER), introduced October 6, 2008, at 0.25% initially—over extending credit, particularly to riskier or smaller borrowers.^[54] Theoretical frameworks show that beyond precautionary thresholds, additional reserves can elevate autarkic funding costs and constrain interbank flows, reducing overall lending efficiency and propping up inefficient capital uses, such as in non-productive sectors sustained by low funding pressures.^[52] For instance, balance sheet frictions during periods of large reserves (e.g., $1.5 trillion by mid-2011) crowd out loan expansion, as the opportunity cost of reserves aligns with but does not exceed loan returns, leading to subdued credit growth amid asset price distortions.^[54] This misallocation persists as banks hoard for convenience yields, potentially exacerbating economic inefficiencies by delaying necessary restructuring in overleveraged entities.^[52]

International Comparisons

European Central Bank Approaches

The European Central Bank (ECB) maintains minimum reserve requirements (MRR) for euro area credit institutions, set at 1% of specified liabilities such as customer deposits and debt securities with maturities up to two years, averaged over a maintenance period of approximately one month.^[55] Excess reserves, defined as current account holdings beyond these MRR, along with balances in the deposit facility, constitute excess liquidity in the Eurosystem.^[56] Prior to the global financial crisis, excess reserves were minimal, with the ECB operating under a scarcity regime through fixed-rate full-allotment tenders and a corridor system where the deposit facility rate (DFR) served as the floor for short-term interest rates.^[56] Following expansive asset purchase programs initiated in 2015, excess liquidity surged, reaching approximately €4.3 trillion by late 2022, with 99% comprising reserves in excess of MRR.^[57] The ECB remunerates excess reserves at the DFR, which was lowered to negative territory (-0.5%) from June 2014 to July 2019 to encourage lending by imposing an opportunity cost on reserve hoarding.^[58] ^[59] This approach contrasted with positive interest on reserves in systems like the Federal Reserve, relying instead on negative rates to steer policy transmission amid ample liquidity.^[56] To mitigate the adverse effects of negative remuneration on bank profitability without fully reversing the incentive structure, the ECB introduced a two-tier system (TTS) for reserve remuneration in September 2019.^[60] Under the TTS, a portion of excess reserves—calculated as six times the MRR—is exempted from the negative DFR and remunerated at 0%, while the remainder receives the DFR; this calibration aimed to limit the burden on smaller institutions while preserving monetary policy stance.^[55] ^[60] The TTS was suspended in 2022 as the DFR turned positive amid policy normalization, with excess reserves then fully remunerated at the prevailing DFR, which stood at 3.25% as of September 2024.^[58] ^[61] In managing declining excess liquidity through quantitative tightening since 2023—allowing €500 billion in bonds to mature annually—the ECB emphasizes active bank liquidity management, expecting institutions to increasingly recourse to open market operations rather than relying on passive excess holdings.^[62] ^[63] Excess liquidity remained above €2 trillion in 2025, supporting an ample reserves framework where the DFR continues to anchor money market rates, though transmission varies by banks' reserve levels during tightening cycles.^[63] ^[64] This evolution reflects the ECB's adaptation of corridor-based operations to post-crisis realities, prioritizing rate control over reserve scarcity.^[56]

Bank of England and Other Examples

The Bank of England remunerates central bank reserves at its Bank Rate, which serves as the primary tool for implementing monetary policy in an ample reserves framework established following quantitative easing operations. This remuneration applies uniformly to both required and excess reserves, eliminating incentives for banks to lend reserves below the Bank Rate and thereby supporting control over short-term interest rates. Since the initiation of QE in March 2009, asset purchases have expanded the Bank's balance sheet, generating approximately £895 billion in central bank reserves held by commercial banks as of recent estimates, with aggregate reserves largely determined by the scale of these purchases rather than demand for settlement balances.^[65]^[65] This policy has drawn scrutiny for its fiscal implications, as interest payments on QE-induced reserves—remunerated at rates such as 5.25% in 2024—effectively transfer public funds to private banks, amounting to an estimated 1.5% of GDP in transfers during periods of elevated rates. Proposals to tier or limit remuneration on excess reserves created via QE have surfaced to mitigate these costs, potentially saving up to £55 billion over five years, though central bank officials argue that full remuneration is essential for maintaining policy effectiveness and avoiding distortions in interbank lending. In July 2025, the Bank affirmed its intent to sustain an "ample" reserves regime rather than reverting to scarcity, aligning with post-QE normalization strategies while preserving operational flexibility.^[66]^[67] Among other central banks, the Bank of Japan has remunerated excess reserves since October 2008, initially as a means to manage liquidity during unconventional easing, with the policy rate applied to a portion of excess balances to steer short-term rates amid vast reserve accumulation from prolonged QE exceeding ¥500 trillion by 2024. This approach supported Japan's negative interest rate policy until March 2024, when rates shifted positive, yet excess reserves—far surpassing required ratios—continue to predominate, with recent hikes prompting record interest outflows from the Bank as normalization advances.^[68]^[69]^[70] The Swiss National Bank employs a tiered remuneration system for sight deposits, exempting a base amount up to three times required reserves from negative rates while applying the policy rate to excess holdings above exemption thresholds, a framework adjusted in June 2025 to impose effective negative rates on oversized excess reserves to incentivize redistribution among banks and sustain money market functionality. This tiering, which generated variation in bank-level exposure following its expansion, aims to balance liquidity provision against deflationary pressures without fully remunerating all excess at the policy rate, contrasting uniform approaches elsewhere.^[71]^[72]

Recent Trends

Quantitative Tightening and Reserve Reduction (2022–Present)

The Federal Reserve commenced quantitative tightening (QT) on June 1, 2022, by capping the reinvestment of principal payments on maturing Treasury securities at $60 billion per month and on agency mortgage-backed securities at $35 billion per month, allowing the balance sheet to contract organically.^[73] This followed the balance sheet's expansion to a peak of approximately $8.9 trillion amid pandemic-era asset purchases, with the policy designed to normalize the Fed's footprint in financial markets while maintaining ample reserves to support smooth implementation of monetary policy.^[74] Total reserve balances, which had stabilized around $3.2 trillion to $3.3 trillion in mid-2022 after earlier peaks exceeding $4 trillion, initially held steady as liquidity drained primarily from the overnight reverse repurchase agreement (ON RRP) facility, which reached $2.55 trillion in December 2022 before declining sharply.^[75]^[76] As QT progressed, the balance sheet shrank by $2.19 trillion by April 2025, reducing total assets to about $6.7 trillion, with reserves beginning to contract more noticeably once ON RRP usage approached zero by mid-2025.^[74]^[77] Reserve levels, hovering near $3.3 trillion through much of 2024 and early 2025 (e.g., $3.356 trillion in June 2025), fell below $3 trillion by October 2025, reaching $2.98 trillion in the week ending October 1—the lowest since early 2023—reflecting the shift of excess liquidity absorption to bank reserves.^[75]^[78] This reduction occurred without significant market stress, as the ample reserves framework—established post-2008—prioritizes avoiding scarcity-driven volatility in short-term funding rates.^[74] In response to diminishing ON RRP buffers and approaching reserve adequacy thresholds, the Federal Open Market Committee slowed QT's pace in March 2025, effective April 1, by lowering the Treasury securities redemption cap to $5 billion per month while maintaining the MBS cap at $35 billion.^[79]^[80] By October 2025, Federal Reserve Chair Jerome Powell indicated the balance sheet drawdown process was nearing completion, with projections for QT to conclude in early 2026 or sooner to prevent reserves from falling into shortage, thereby preserving operational efficiency in the federal funds market.^[81]^[82] Despite the drawdown, reserves remained sufficient to support banking system liquidity, with no elevation in federal funds rate volatility observed.^[83]

Implications for Future Policy Normalization

The Federal Reserve's ongoing quantitative tightening (QT), initiated in June 2022, has reduced excess reserves from approximately $4.2 trillion at the program's start to around $3.0 trillion by mid-2025, aiming to normalize the balance sheet while maintaining an ample reserves framework to support effective monetary policy implementation.^[79] This process involves allowing up to $60 billion in Treasury securities and $35 billion in agency mortgage-backed securities to roll off monthly, though caps were adjusted downward in April 2025 to $5 billion for Treasuries to mitigate liquidity risks as reserves approach potentially tighter levels.^[79] Policymakers emphasize that full normalization does not entail returning to pre-2008 scarce reserves conditions, given structural changes like higher regulatory liquidity requirements and the expanded role of nonbank intermediaries, which necessitate a larger steady-state balance sheet estimated at $2.5–3.5 trillion for ample reserves.^[84] Failure to calibrate this could disrupt short-term funding markets, as evidenced by the 2019 repo market stress when reserves dipped below $1.5 trillion, prompting temporary interventions.^[85] Future normalization hinges on precise estimation of the "minimum level of ample reserves," a threshold below which interbank lending pressures could emerge, complicating the Federal Open Market Committee's (FOMC) ability to steer the federal funds rate primarily through adjustments to the interest rate on reserves (IOR).^[85] Empirical analysis suggests this level may exceed $2.5 trillion, factoring in bank demand for precautionary balances amid volatile flows from Treasury issuance and money market fund activity; crossing it risks elevating term funding costs and constraining credit intermediation without proactive tools like the overnight reverse repurchase facility (ON RRP).^[74] The Fed's framework incorporates standing liquidity facilities and flexible redemption caps to preempt scarcity, but historical precedents indicate that rapid reserve drainage—such as during the 2017–2019 unwind—can amplify financial frictions if not offset by forward guidance or balance sheet recalibrations.^[86] As QT progresses, reliance on IOR as the policy floor may intensify, potentially requiring periodic hikes to prevent federal funds rates from drifting below target amid uneven reserve distribution across depository institutions.^[87] Broader implications include enhanced policy flexibility in an ample reserves regime, where normalization supports tighter control over inflation dynamics by reducing excess liquidity without reverting to corridor systems that proved unstable pre-2008.^[88] However, sustained high excess reserves could embed distortions, such as suppressed money multiplier effects and incentives for banks to hold low-yield reserves over riskier lending, necessitating vigilant monitoring of credit allocation during future cycles.^[89] Projections as of October 2025 suggest QT may pause or reverse if reserves near scarcity indicators, with analysts anticipating a halt amid recent rate volatility to safeguard market functioning, underscoring the trade-off between balance sheet efficiency and systemic stability.^[90] This adaptive approach prioritizes empirical reserve demand metrics over rigid targets, ensuring normalization aligns with evolving economic conditions rather than arbitrary size reductions.^[91]

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[PDF] The Pre-Crisis Monetary Policy Implementation Framework
In particular, small banks with limited access to funding markets demanded some level of excess reserves each day—typically between $1.5 billion and $2 billion— ...
[17]
The Fed's New Monetary Policy Tools
Aug 3, 2020 · Prior to 2008, the Fed used a framework in which it supplied a limited amount of reserves to the banking system. Traditionally, total bank ...
[18]
Excess Reserves - Overview, How It Works, Interbank Rate
Excess reserves are cash and deposits held by a financial institution exceeding the reserve requirement set by an authority.
[19]
How Did the Fed Funds Market Change When Excess Reserves ...
Prior to the 2007-2008 financial crisis, excess reserves in the U.S. banking system were scarce. ... Federal Reserve Bank Seal.Missing: pre- | Show results with:pre-
[20]
Excess Reserves: Oceans of Cash
Feb 12, 2015 · Excess reserves—cash funds held by banks over and above the Federal Reserve's requirements—have grown dramatically since the financial crisis ...<|separator|>
[21]
Excess Reserves of Depository Institutions (DISCONTINUED) - FRED
Graph and download economic data for Excess Reserves of Depository Institutions (DISCONTINUED) (EXCSRESNS) from Feb 1984 to Aug 2020 about reserves, ...Missing: 2008 | Show results with:2008
[22]
How the Federal Reserve Got So Huge, and Why and How It Can ...
Feb 7, 2024 · It was necessary for the Fed to pay interest on excess reserves to conduct monetary policy once the Fed began offering more reserve balances ...
[23]
The Fed - The Recent Evolution of the Federal Funds Market and its ...
Jul 11, 2024 · These LSAPs expanded the Federal Reserve's balance sheet substantially, which resulted in reserves growing from about $40 billion in 2008 to ...Figure 1. Fed Funds Rate And... · Figure 3. Fed Funds Market... · Figure 4. Effr Spread To...Missing: surge | Show results with:surge
[24]
Interest on Reserves: History and Rationale, Complications and Risks
On October 6, 2008, the Federal Reserve Board announced plans to begin paying interest on required and excess reserves at rates 10 and 75 basis points, ...
[25]
FRB: Interest on Excess Reserves as a Monetary Policy Instrument
Mar 26, 2010 · In October 2008, the Federal Reserve began paying interest on required and excess reserve balances. This note reviews the experience of eight ...
[26]
Ten Years Later—Did QE Work? - Liberty Street Economics
May 8, 2019 · The program was extended and expanded in March 2009, and, by the end of QE1 in March 2010, the Fed had bought $1.25 trillion in MBS, $175 ...
[27]
The Fed's bigger balance sheet in an era of “ample reserves”
May 17, 2019 · The Fed's balance sheet expanded by over $3.5 trillion during and after the Great Recession as a result of trillions of dollars in bond-buying, ...
[28]
The Crisis Is Over: It Is Time to End Experimental Monetary Policy
Nov 9, 2017 · When it began paying IOER in October 2008, the Fed set the IOER rate at 0.75 percent, well below the federal funds target rate of 1.5 percent. ( ...
[29]
The Effect of Interest on Reserves on Monetary Policy | Richmond Fed
Banks will be unwilling to make loans to the public at a rate lower than what they can earn from the Fed for holding excess reserves, so the IOR rate can be ...
[30]
Interest on Excess Reserves and U.S. Commercial Bank Lending
Oct 18, 2019 · Over the past decade, the interest on excess reserves (IOER) rate has become a key administered rate used by the Federal Reserve to control ...
[31]
What can public Fedwire payments data tell us about ample ...
Jul 18, 2025 · This figure displays a time series chart from January 2015-March 2025 of monthly fedwire payments, reserves, and reserves as a share of fedwire payments.Missing: current | Show results with:current
[32]
Bank Reserves since the Start of Quantitative Tightening
Apr 18, 2024 · The Fed currently operates in an implementation framework known as a floor system. By paying interest on reserve balances (known as the IORB ...<|separator|>
[33]
Large-Scale Asset Purchases - Federal Reserve Bank of New York
During the period from late 2008 through late 2014, the FOMC provided further monetary policy easing by authorizing three rounds of large-scale asset purchase ...
[34]
[PDF] Economic Information Newsletter: Quantitative Easing Explained
Quantitative easing (QE) is when the Fed makes large-scale asset purchases, like mortgage-backed and Treasury securities, to bolster financial markets.<|separator|>
[35]
Chronology of Fed's Quantitative Easing - Yardeni Research
Under the program, the Fed purchased $1.5trillion in bonds, including $1.2 trillion in US Agency debt and MBS and $300 billion in US Treasuries. Mar 16, 2009
[36]
How the Federal Reserve's Quantitative Easing Affects the Federal ...
Sep 8, 2022 · In response to the 2007–2009 financial crisis, the Federal Reserve decreased interest rates and significantly expanded its balance sheet ...
[37]
Is the recent buildup of bank reserves inflationary?
May 1, 2010 · An increase in reserves could lead to inflation · However, the new authority to pay interest on reserves allows the Fed to mitigate inflationary ...
[38]
Why Are Banks Holding So Many Excess Reserves?
The quantity of reserves in the U.S. banking system has risen dramatically since September 2008. Some commentators have expressed concern that this pattern ...Missing: dynamics | Show results with:dynamics
[39]
Inflation—why now and not post-2008? - Fraser Institute
May 21, 2022 · Once again the banks held on to the new money as excess reserves, which doubled from US$1.5 trillion to US$3.2 trillion between February and May ...
[40]
Monetary Policy in a World with Interest on Reserves
The Fed now pays interest on required and excess reserve balances, having been granted the authority by Congress and putting the policy into place ahead of ...Missing: mechanism | Show results with:mechanism
[41]
Central bank reserves and bank lending spreads
Aug 20, 2020 · We provide empirical evidence that an increase in reserves lowers banks' lending spreads, i.e. interest rates relative to maturity-matched risk ...
[42]
Better than risk‐free: Reserve premiums and bank lending
Dec 17, 2024 · In two-stage estimations5, results indicate reserve premiums are associated with a decrease in bank-level lending by -5.1%, which amounts to -$ ...
[43]
Bank lending and interest on excess reserves: An empirical ...
This paper econometrically tests for effects on bank lending of the Federal Reserve's policy of paying interest on excess reserves (IOER).
[44]
[PDF] Why Are Banks Holding So Many Excess Reserves?
High excess reserves are a byproduct of the Fed's lending facilities and asset purchases, and the Fed's extension of credit to banks during a crisis.<|control11|><|separator|>
[45]
Interest on reserves, regime shifts, and bank behavior - ScienceDirect
This paper demonstrates that in the post-2008 environment with interest on reserves, monetary policy actions can generate regime shifts.
[46]
Money, Reserves, and the Transmission of Monetary Policy: Does ...
Aug 10, 2010 · The paper argues that the standard money multiplier model is implausible in the US, and the transmission mechanism does not work through it.<|separator|>
[47]
Decomposing US Money Supply Changes since the Financial Crisis
Starting in September, 2008, the multiplier began to collapse to its low level of 0.82 reached in January of 2012, a decline of slightly over 50 percent.7 Table ...
[48]
M1 Money Multiplier (DISCONTINUED) (MULT) | FRED | St. Louis Fed
Graph and download economic data for M1 Money Multiplier (DISCONTINUED) (MULT) from 1984-02-15 to 2019-12-04 about multiplier, M1, monetary aggregates, ...Missing: 2000-2020 | Show results with:2000-2020
[49]
The monetary multiplier and bank reserves - FRED Blog
Jul 31, 2023 · Interest on excess reserves decreases the cost of holding them. As a result, banks are willing to hold more reserves relative to other assets, ...
[50]
Teaching the Linkage Between Banks and the Fed: R.I.P. Money ...
Sep 17, 2021 · The Federal Reserve began paying interest on required and excess reserve balances in October 2008. Between October 2008 and March 2020, the ...
[51]
Why the money multiplier has remained persistently so low in
The main reason for this collapse is to be found in the significant increase in banks' excess reserves and the modest increase in deposits. The weak growth of ...
[52]
https://www.nber.org/papers/w29680
[53]
[PDF] Collective Moral Hazard and the Interbank Market - SSRN
Our paper relates most closely to the collective moral hazard literature, particularly Farhi and Tirole (2012), Davila and Walther (2020), Keister (2016), and ...
[54]
[PDF] Bank Lending in Times of Large Bank Reserves
“Why Are Banks Holding So. Many Excess Reserves?” Current Issues in Economics and Finance, Federal. Reserve Bank of New York. [14] Martin, Antoine (2006). “ ...
[55]
Excess reserves and excess liquidity | Deutsche Bundesbank
Excess reserves are deposits by credit institutions on settlement accounts with the central bank that exceed the minimum reserve requirements.
[56]
[PDF] Excess reserves and the implementation of monetary policy of the ECB
Excess reserves refer to the current account holdings of banks with their central bank beyond required reserves. In the past, excess reserves were regarded ...
[57]
How to conduct monetary policies. The ECB in the past, present and ...
This led to reserve balances of the banking system of €4.3 trillion, 99 % of which are reserves in excess of minimum reserve requirements (of 1 %).
[58]
What are excess reserves? - ECB interest rates - Banco de España
Excess reserves are the amount of reserves held by banks at their central bank in excess of the reserve requirements. At present, a two-tier system (TTS) is ...
[59]
ECB Deposit Facility Rate for Euro Area (ECBDFR) - FRED
The rate on the deposit facility, which banks may use to make overnight deposits with the Eurosystem. Data refer to the changing composition of the Euro ...
[60]
Two-tier system for remunerating excess reserve holdings
The rate on the deposit facility – when it is positive – is paid only to the extent that banks make recourse to this standing facility as opposed to holding ...
[61]
Key ECB interest rates - European Union
Effective 18 September 2024, the spread between the rate on the main refinancing operations and the deposit facility rate was reduced to 15 basis points.Missing: excess | Show results with:excess
[62]
Managing liquidity in a changing environment
Mar 18, 2025 · It emphasises that, as excess liquidity becomes less ample, the ECB, both as a monetary policy authority and as a supervisor, expects that banks ...
[63]
Euro zone banks must get into habit of tapping ECB for cash, ECB ...
Mar 18, 2025 · The ECB is allowing about 500 billion euros of bonds to expire this year, meaning that excess liquidity will still be over 2 trillion euros at ...
[64]
Excess Reserves and Monetary Policy Tightening - IDEAS/RePEc
We show that the transmission of the European Central Bank's (ECB) recent monetary policy tightening differs across banks depending on their level of excess ...
[65]
Bank of England Market Operations Guide: Our objectives
Jun 25, 2025 · At the same time, remuneration of reserves at Bank Rate means that firms have no incentive to lend excess reserves at rates below Bank Rate.
[66]
The new operating procedures of the Bank of England: A bonanza ...
Jun 24, 2024 · When central banks pay interest on bank reserves, they create money which they transfer to banks. Today in the UK this transfer amounts to 1.5% ...
[67]
Government could save £55bn over next five years by limiting Bank ...
Nov 14, 2023 · The government could save £55bn over the next five years if it limits the amount of money the Bank of England pays interest on to commercial banks.
[68]
[PDF] Interest on Excess Reserves as a Monetary Policy Instrument
Jan 21, 2010 · In particular, if excess reserves are still plentiful when the time comes to tighten monetary policy, will raising the rate of interest paid ...
[69]
What is the reserve requirement system? What are excess reserves?
Under the reserve requirement system, relevant financial institutions are required to hold a certain percentage (referred to as the reserve requirement ratio) ...
[70]
BOJ's Interest Payments on Excess Reserves Jump After Rate Hikes
Nov 27, 2024 · The Bank of Japan's interest payments on excessive reserves reached a record high, underscoring the costs of policy normalization after it ...
[71]
SNB Introduces Stealth Negative Rate to Protect Money Market
Jun 19, 2025 · The Swiss National Bank's "tiered remuneration" system means banks will face negative rates if they hold excess reserves above a certain ...
[72]
Tiers of joy? Reserve tiering and bank behavior in a negative-rate ...
We study the effects on bank behavior of a large and unanticipated change in reserve tiering by the Swiss National Bank that generated substantial variation ...
[73]
Plans for Reducing the Size of the Federal Reserve's Balance Sheet
May 4, 2022 · For Treasury securities, the cap will initially be set at $30 billion per month and after three months will increase to $60 billion per month.Missing: peak present
[74]
QT, Ample Reserves, and the Changing Fed Balance Sheet
Apr 15, 2025 · Selling securities reduced the size of the Fed's balance sheet and decreased the level of bank reserves, a strategy which, in turn, increased ...Missing: explanation | Show results with:explanation
[75]
Reserves of Depository Institutions: Total (TOTRESNS) - FRED
Graph and download economic data for Reserves of Depository Institutions: Total (TOTRESNS) from Jan 1959 to Aug 2025 about adjusted, reserves, and USA.
[76]
Fed nears QT crossroads as 'excess liquidity' evaporates: McGeever
Oct 2, 2025 · The Fed's overnight reserve repo (RRP) facility has dropped to $78 billion, a fraction of the $2.55 trillion peak in December 2022. This may not ...
[77]
Monetary Policy Report – June 2025 - Federal Reserve Board
Since early January 2025, total Federal Reserve assets have decreased $176 billion, leaving the total size of the balance sheet at $6.7 trillion, $2.2 trillion ...
[78]
US Bank Reserves Decline Further Below Key $3 Trillion Mark
Oct 2, 2025 · Bank reserves fell by about $20.1 billion to $2.98 trillion in the week through Oct. 1, the lowest level since January. The drop in bank ...
[79]
Policy Normalization - Federal Reserve Board
Beginning on April 1, 2025, the Committee reduced the monthly redemption cap on Treasury securities from $25 billion to $5 billion, further slowing the pace of ...Missing: quantitative | Show results with:quantitative
[80]
What are the implications of the Fed slowing down its balance sheet ...
Jun 13, 2025 · In March 2025, the Federal Reserve (Fed) announced a slowdown in the pace of its balance sheet reduction process beginning in April.
[81]
Fed's Powell says the end of balance sheet drawdown process may ...
Oct 14, 2025 · The QT process, which has been running since 2022, is designed to remove excessive amounts of liquidity the Fed added to financial markets ...
[82]
When might the Fed end its quantitative tightening (QT) program?
The Fed is poised to end QT sometime in 1H2025 once RRP drainage is complete. Should the level of reserves fall below this threshold, however, its likely to ...
[83]
Reserve Demand Elasticity - Federal Reserve Bank of New York
October 2025 Update. The elasticity of the federal funds rate to reserve changes is very small and statistically indistinguishable from zero.
[84]
Balance Sheet Reduction and Ample Reserves
Sep 29, 2025 · Like many other advanced economy central banks, the Federal Reserve is in the process of shrinking its balance sheet following its material ...
[85]
Fed Balance Sheet Normalization and the Minimum Level of Ample ...
This added cost can push interbank rates below interest on reserves, as noted for example in the 2017 paper "Excess Reserves and Monetary Policy Implementation.
[86]
The financial market effects of unwinding the Federal Reserve's ...
This paper provides a first analysis of the financial market effects of balance sheet normalization based on the US experience between 2017 and 2019.
[87]
[PDF] Policy Normalization Principles and Plans - Federal Reserve Board
Reserve intends to move the federal funds rate into the target range set by the Com- mittee primarily by adjusting the interest rate it pays on excess reserve ...
[88]
Speech by Chair Powell on the economic outlook and monetary policy
Oct 14, 2025 · Normalizing the size of our balance sheet does not mean going back to the balance sheet we had before the pandemic. In the longer run, the size ...
[89]
The Mechanics of Fed Balance Sheet Normalization
Aug 23, 2023 · This policy, termed balance sheet “normalization” or “quantitative tightening” (QT), is designed to drain excess liquidity from the banking system.
[90]
https://www.reuters.com/business/finance/some-analysts-see-imminent-fed-halt-balance-sheet-drawdown-rate-turbulence-2025-10-20/
[91]
Speech by Governor Waller on the balance sheet
Jul 10, 2025 · Second, we use short-term reserves to buy the longer duration assets which leads to a maturity mismatch between our assets and our liabilities.