Better than risk-free: Reserve premiums and bank lending

When the Federal Reserve first paid interest on excess reserves (IOER) in October 2008, banks faced a choice to earn a “better than” risk-free rate, or lend to earn a higher, riskier rate. Evidence suggests the “reserves-lending puzzle” is not driven by endogeneity from reverse causality, flight to safety, or increased Treasury supply, but by the introduction of the “reserve premium” (IOER-3MT), which is associated with a reduction of domestic bank-level lending by -5.1% (-$420.2B). Findings suggest the reserves risk channel can aid in restricting inflation. Additionally, recent Senior Financial Officer Surveys corroborate the conclusions presented in this paper.