Wednesday, 7 September 2016

Are minimum reserve requirements a tax on commercial banks?

If they are, then as argued by Donald Kohn, that supports the argument for paying banks interest on reserves. (Kohn is a former vice chairman of the Board of Governors of the Fed.)

Well strikes me that one of the basic ideas behind minimum reserves is that it helps ensure bank safety, and forcing people or organisations to behave in a safe manner is not a tax.

Take cars. Where cars are required to keep to some speed limit, is that a “tax on car drivers”? Of course not! It’s simply a way of forcing drivers to behave safely. So to that extent, minimum reserves are not a tax on banks: they are simply a way (however flawed) of making banks behave safely: after all, commercial banks are very tempted to take excessive risks in the knowledge that if anything goes wrong, the TBTF subsidy (i.e. taxpayers) will come to their rescue.

Another reason for minimum reserve requirements is that it is a way of controlling interest rates, though actually ADJUSTING reserve requirements with a view to adjusting interest rates seems to be a tool employed more often in China than the West.

But there again, the objective is to damp down on commercial bank irresponsibility. That is, commercial banks behave in a PRO-CYCLICAL manner, not an anti-cyclical manner: they lend like there’s no tomorrow in a boom (exactly what we don’t want them to do). Then come the bust, they do the opposite: call in loans, etc. Again, that’s exactly what we do not want them to do.

So where reserve requirements are used to adjust interest rates, there again, it’s a case of forcing private banks to behave responsibly. That cannot be construed as a tax on private banks.

And finally, I am grateful to George Selgin for his recent article “Has the Fed Been Breaking the Law?” It was that article which raised the “tax on banks” point and got me thinking about the  subject – in as far as what goes on inside my skull can be described as “thinking”….:-)

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