Implementing policy under the current and proposed systems

Under the current system, securitization reduces banks’ need to raise capital to support increased deposit liabilities to support securitized loans. But capital requirements reduce banks’ incentives to make loans that cannot be securitized. The tables in this chapter show how shifting reserves to the liability side of financial firms’ balance sheets increases the effectiveness of monetary initiatives. When the Fed acquires assets from a financial firm under repurchase agreements, it shrinks the asset side of the firms’ balance sheet while augmenting the liability side with reserves and creates an incentive to use the new interest-free reserves to buy new interest-earning assets. Similarly, when it returns assets to an institution and extinguishes reserves, the institution has insufficient liabilities to back its assets and must sell assets to adjust its balance sheet.