Bank Lending and Interest on Excess Reserves

Abstract

This paper analyzes the relationship between bank lending and the Federal Reserve's policy of paying interest on excess reserves (IOER). We argue that the Fed's IOER policy deviates from the standard interest-rate floor framework in ways that influence banks' incentives to hold loans and reserves. Using quarterly data from the start of 2000 through the third quarter of 2017, we find that banks' holdings of loans and reserves are related to GDP growth and employment but are not related to measures of loan demand or economic uncertainty. Accounting for these factors, banks' loan holdings are inversely related to both the rate of IOER and to its premium above short-term market interest rates. We estimate that the Fed's IOER policy accounts for more than half of the post-crisis decline in bank loan allocations.

Keywords: Federal Reserve, Banks, Lending, Reserves; IOER, Monetary policy

JEL Classification: E51, E52, E58, E44, E47