What Does a Commercial Bank Do With Excess Reserves?

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A commercial bank, when it has excess reserves, will often keep the reserves in order to better fund upcoming transactions or they lend to banks in the Federal Reserve System because this involves interest. Lending to banks at the Fed is also a wise investment for a commercial bank because it is a risk-free deposit.

Commercial banks do not lend out their reserves although not doing so can harm investors who need to ask for a loan. In bank lending, deposits and loans are considered equal across the banking system because when banks create new loans they must also create a new balancing deposit. Unlike the popular belief, banks are not able to lend out existing deposits to people or companies.

The Fed has been doing quantitative easing since 2009 and QE means buying assets that are held by those banks and investors that are in the private sector. When the Fed buys from various banks, those banks only need to change an asset for a new reserve, but that does not require a change in deposit so investors receive dollars credited directly to their bank deposit accounts that are newly created dollars. This means that bank deposits will rise and the excess reserves will continue to grow in commercial banks.