Interbank market frictions drive bank demand for excess reserves
A Bank for International Settlements study finds that payment flow volatility and thin interbank trading drive banks to hold costly excess central bank reserves. The paper analyzes weekly Riksbank microdata to evaluate drivers behind bank-level liquidity buffers.
Precaution over price
Banks maintain substantial excess balances at the central bank despite the yield penalty of foregoing higher-return instruments.
Active interbank participants increase their reserve buffers when payment flows turn volatile and when peer borrowing costs escalate.
Lower aggregate trading volume across money markets also prompts active institutions to hold more central bank liquidity, relying on self-insurance when counterparties are scarce.
Conversely, inactive institutions maintain persistent balances that also expand alongside payment volatility.
Crucially, the researchers find no robust evidence that post-crisis liquidity regulation drives excess reserve demand.
Sweden's elastic window
To trace reserve demand without distorting supply effects, the study exploits Sveriges Riksbank's operational framework, where central bank reserve supply is fully elastic and banks reveal their excess demand weekly.
Most existing empirical models evaluate reserve appetite exclusively at the aggregate banking system level.
By utilizing granular bank-level microdata, this setting separates individual liquidity preferences from central bank balance sheet policy during quantitative tightening.
Friction dictates floor size
The study provides a sobering reality check for central banks trimming balance sheets.
Because market fragmentation traps reserves in isolated pockets, minimum reserve floors must remain wider than anticipated.
Policymakers must repair interbank market plumbing before assuming liquidity buffers can shrink.