Hernández de Cos warns abundant reserves can breed dependence
Pablo Hernández de Cos, General Manager of the Bank for International Settlements (BIS), said large reserve holdings can cushion liquidity shocks but also increase banks' dependence on liquidity. He spoke at the ECB Conference on Money Markets in Frankfurt.
Four frameworks, competing trade-offs
Hernández de Cos distinguished scarce, ample, abundant and tiered reserve frameworks.
All can deliver monetary control and financial stability, but their costs differ.
Brazil, India and Korea operate with scarce reserves; the euro area has high reserve levels.
The Swiss National Bank uses tiering to sustain trading despite abundant reserves.
Higher reserves keep market rates closer to policy rates and cushion liquidity shocks, but weaken interbank trading incentives and can distort resource allocation.
Lorrie Logan's 2023 argument favored ample reserves because supplying them costs little; Isabel Schnabel in 2025 stressed broader social costs.
Scarce-reserve rate deviations typically remain within a few basis points, with limited transmission to other short-term rates.
Liquidity insurance changes bank behavior
Since Sveriges Riksbank adopted high reserve levels in 2020, around 50 percent of counterparties have avoided all money market segments.
Fragmentation can raise precautionary reserve demand.
Liquidity Coverage Ratio rules need not raise demand because other liquid assets qualify.
Faster runs in 2023, stigma and operational barriers increase reserves' insurance value.
US evidence links reserve expansion to more uninsured deposits and credit lines.
Euro area balance sheet reduction began in 2022; liquidity dependence may not reverse proportionally.
No universal reserve target
Hernández de Cos sees no single optimal reserve level across jurisdictions.
Large buffers insure banks against stress, but endogenous responses can increase liquidity vulnerability.
Whether those responses reverse during balance sheet reduction remains unresolved, despite evidence of smooth reductions.
Source: The central bank balance sheet
IN: