How can banks hold only $0 now in deposits?! Can someone break this down

Question

Article: https://www.federalreserve.gov/monetarypolicy/reservereq.htm

In: Economics

Answer 1

The reserve requirement ratio determines the minimum amount of reserves banks have to hold relative to their deposits. Banks will still hold reserves even if there is no requirement to do so. Canada for example has not had a reserve requirement since 1992.

A common misconception is that banks need deposits first before they can lend out money. What banks actually do is they create a new deposit when they lend money. The money is not taken from somewhere, it is created when the loan is made. A deposit is just the amount of money the bank owe the deposit owner. If you borrow 1 million dollars from a bank, you owe the bank 1 million dollars that has to be paid back in x number of years with interest. In return, the bank now owe you 1 million dollars.

Reserves should not be confused with the deposits that banks have. Reserves is a type of money issued by the central bank, and is located on the asset side of bank balance sheets. Banks hold reserves in their account at the central bank. Only banks can own central bank reserves, and they are used to settle transactions between banks. Banks need to settle transactions between each other every day. Let’s say that you buy something at a store with a debit card. If the store is not using the same bank as you, your bank needs to transfer money to the bank used by the store to settle the transaction.

Now banks do not do this for every transaction that happens between banks. Instead they calculate the necessary net transfers they need to make to other banks, but the point remains the same. This is what reserves are used for. Sometimes banks do not have enough reserves to settle their transactions. In that case they will typically borrow money from other banks, or in certain cases from the central bank.

The amount of deposits is not necessarily related to the amount of reserves a bank has. Although as explained above, if enough depositors decides to transfer their deposits to other banks, the bank will need to either have or obtain enough reserves to settle the transactions.