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Bank Reserves Go Negative

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Imagine a major bank telling customers: "We have no cash reserves so we can't give you a loan."

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I have been watching a chart of Borrowed Bank Reserves for several weeks. The action is unprecedented.

Borrowed Reserves of Depository Institutions

Click to enlarge

The
NFORBES Chart above is courtesy of the St. Louis Fed.

Here's an interesting excerpt from the book Investing Public Funds by Girard Miller about borrowed reserves:

"Another useful indicator of the Federal Reserve's relative monetary policies can be found weekly in the Federal Reserve data. A key statistic is the net free reserves or net borrowed reserves line item. This statistic measures the degree to which depository institutions have found it necessary to obtain funds in the Fed Funds market and through the Fed discount window in order to obtain required reserves.

During periods of central bank credit-tightening operations, the depository sector might find it necessary to borrow funds to meet reserve requirements. This practice results in net borrowed reserves, which shows as a negative number. Conversely, if ample funds are available through the banking system to meet reserve requirements, banks can become net lenders of reserves through the Fed Funds markets."

Given that the Fed is not in a credit tightening mode, we must look for a better explanation. Here it is: Banks in aggregate have now burned through all of their capital and are forced to borrow reserves from the Fed in order to keep lending.

Detail comes from the Federal Reserve H3 Release.

Table 2, Not Seasonally Adjusted Reserves in Millions of Dollars

Click to enlarge


Total reserves for two weeks ending January 16 are $39.988 billion. Inquiring minds are no doubt wondering where $40 billion came from. It's a good question. The answer is the Term Auction Facility. You can see that figure in Table 1 of the H3 release, accessible through the link above.

Were it not for the Term Auction Facility, banks would have had to raise $40 billion in capital by selling assets or some other means. We will look at "other means" in just a moment.

For now, the Fed is not disclosing who is borrowing under the Term Auction Facility, probably out of fear that people just might find out what banks are capital-impaired and by how much.

January 29 TAF Auction

Forbes is reporting Fed's TAF auctions 30 bln usd 28-day loans at 3.123 pct:

The Federal Reserve's latest loan auction through its Term Auction Facility (TAF) produced the lowest interest rate, lowest bid-to-cover ratio and fewest bidders yet. The lower demand suggests an improved liquidity situation in financial markets.

Yesterday's auction of 30 bln usd 28-day loans came in at a 3.123 pct interest rate, a 1.25 bid-to-cover ratio and 52 bidders. This was the fourth auction under the new TAF program designed to relieve pressure in the short-term, inter-bank funding market.

The Role Of The Monolines

What happens if Ambac (ABK) and MBIA (MBI) are downgraded? That too is a good question. Let's take a look.

MarketWatch is reporting Banks may need $143 billion in fresh capital:

If bond insurers are downgraded a lot, banks will need as much as $143 billion in fresh capital to absorb the impact, Barclays Capital estimated Friday. Citigroup Inc. (C), Merrill Lynch & Co. (MER) Bank of America Corp. (BAC), and Wachovia Corp. (WB) are among U.S. banks most exposed to bond insurers, or "monolines" as they're also known, Barclays Capital wrote to investors.

The Telegraph is reporting Banks 'face a further $300bn sub-prime hit':

The world's financial institutions will have to write down a further $300bn (£152bn) of US sub-prime losses before the crisis is over, according to a study by consulting firm Oliver Wyman.

"While governments, central banks and regulators scramble to address the aftermath of the sub-prime fallout, several other crises are mounting."

Tumbling property prices - especially in the UK and Spain - a weakening dollar, a possible collapse in commodity prices, and a fall in Chinese and Indian stocks will "disrupt" the global economy, the report claimed.

As noted in Banks Attempt To Freeze Balance Sheets, "Large money center banks have virtually frozen their balance sheets, reluctant to lend even to good credit," according to Scott Anderson, a senior economist at Wells Fargo.

However, rising numbers of foreclosures are forcing assets on to bank balance sheets in spite of that desire to freeze. It's no wonder banks are spooked by those walking away from debt. See 60 Minutes Legitimizes Walking Away for details.

Banks Raise ATM Fees to $3.00

One method of raising capital is to increase fees. $3 ATM Fees are one such method.

"They're looking for ways to make up for the losses and nickel and diming appears to be the only way they can do it," Consumer Affairs analyst Joseph Enoch said. Today, the average ATM fee is $1.78, while five years ago it cost a little more than a $1 to retrieve money from a bank with which you didn't have an account.

In some areas, JP Morgan Chase (JPM), Bank of America and Wachovia fees have hit $3 for non-customers. Some banks now charge their own customers a fee for the convenience of using an ATM to the disdain of some.

Another way to raise cash, and a very expensive one at that, is to offer way-above-market rates on savings deposits and CDs. Let's take a look at some current offers on savings accounts.

Savings Deposit Rates

Click on chart to enlarge.
Chart courtesy of Bankrate.Com.

Any bank paying those rates on savings accounts is desperate for cash. Those looking for candidate banks liable to go under need only look at the price banks are willing to pay for capital.

I cannot stress this enough: If you accept these offers, please make sure you never go above the FDIC limit.

$3.00 ATM Fees Will Backfire

As for banks charging $3.00 ATM fees, I think the strategy will backfire in several ways:

  • Some customers will stop using anything but their own bank's ATMs. Instead of getting $1.50 banks will get nothing.

  • Some customers will opt to max out the cash they take on each transaction to minimize the number of transaction fees.

  • Banks charging their own customers will find many switching banks out of resentment.

In the grand scheme of things, $30 billion or $40 billion is not a lot of money. However, when lack of reserves would otherwise prevent lending, it certainly is a lot of money. Imagine a major bank telling customers: "We have no cash reserves so we can't give you a loan." With that in mind, banks are scrambling to raise cash.

Borrowing reserves is expensive, paying 5% on CDs and Savings Deposits is expensive, and in the end, attempting to extract more blood out of consumers by raising ATM fees to $3.00 is going to prove expensive. There are simply no good ways to raise capital. And the problem is going to get far worse before it gets better.

A deepening recession, a falling stock market, plunging commercial real estate, and social acceptance of walking away are all going to exacerbate the problems Bernanke and lending institutions face. A Crash Course For Bernanke on academic theory is coming. It will be interesting to watch how he reacts to it.


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