US excess reserves fall slightly

The credit crunch has produced many crazy charts. This one is typical. It is excess reserves of commercial banks held at the Federal Reserve. What are excess reserves and what is this chart telling us?

US banks are obliged to keep a small proportion of their assets as reserves at the Fed. Excess reserves are cash balances that banks decide to keep at the Fed in excess of their required reserves.

In normal circumstances, banks don't like to keep assets at the Fed. They would rather have these resources lent out where they can earn interest. Usually, banks would use the interbank market to deposit any spare cash and earn a moderate return.

Of course, these are not normal circumstances. Banks are trying to keep hold of cash. They also want to avoid putting anything with other banks. That leaves only the Fed, which has, in effect, replaced the interbank market.

So what does this chart tell us? First, that the Lehman crisis led to an unprecedented surge of excess reserves. Second, excess reserves have fallen slightly, suggesting that things have calmed down a little in recent months. Finally, despite the improvement, excess reserves remain extemely high and banks continue to be reluctant to place any spare liquidity with their sister banks.

In other words, the credit crisis continues.