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Modelling Reserve Demand with Deposits and the Cost of Collateral

Author

Listed:
  • Laurence Bristow

    (Reserve Bank of Australia)

Abstract

The RBA controls short-term interest rates by offering to lend as many reserves as banks demand at a rate close to its target for monetary policy. At this rate, banks' demand drives the amount of reserves the RBA supplies and subsequently the size of its balance sheet. I estimate a substantial increase in Australian banks' reserve demand since the COVID-19 pandemic. I find an increase in banking system deposits explains a large part of the increase in reserve demand through an associated shift to the right in Australian banks' reserve demand curve. The link between deposits and reserve demand suggests banks are willing to pay for the convenience of holding additional reserves to manage payments between depositors, or that banks hold reserves against deposits as a precaution in case of liquidity stress. The value of collateral also shifts banks' reserve demand curve as it changes the price at which banks can fund reserves through the repo market. The role of collateral in explaining the increase in banks' reserve demand is likely small as its value is little changed since the pandemic.

Suggested Citation

  • Laurence Bristow, 2024. "Modelling Reserve Demand with Deposits and the Cost of Collateral," RBA Research Discussion Papers rdp2024-08, Reserve Bank of Australia.
    • Handle: RePEc:rba:rbardp:rdp2024-08
    DOI: 10.47688/rdp2024-08
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    References listed on IDEAS

    as
    1. Smith, A. Lee & Valcarcel, Victor J., 2023. "The financial market effects of unwinding the Federal Reserve’s balance sheet," Journal of Economic Dynamics and Control, Elsevier, vol. 146(C).
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    3. Arrata, William & Nguyen, Benoît & Rahmouni-Rousseau, Imène & Vari, Miklos, 2020. "The scarcity effect of QE on repo rates: Evidence from the euro area," Journal of Financial Economics, Elsevier, vol. 137(3), pages 837-856.
    4. Belinda Cheung & Sebastien Printant, 2019. "Australian Money Market Divergence: Arbitrage Opportunity or Illusion?," RBA Research Discussion Papers rdp2019-09, Reserve Bank of Australia.
    5. Richard Finlay & Dmitry Titkov & Michelle Xiang, 2022. "The Yield and Market Function Effects of the Reserve Bank of Australia's Bond Purchases," RBA Research Discussion Papers rdp2022-02, Reserve Bank of Australia.
    6. Morten L. Bech & Antoine Martin & James J. McAndrews, 2012. "How the High Level of Reserves Benefits the Payment System," Liberty Street Economics 20120227, Federal Reserve Bank of New York.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    monetary policy; money and interest rates; banks;
    All these keywords.

    JEL classification:

    • E49 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Other
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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