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How Well Do Banks Manage Their Reserves?

  • Eduardo Jallath-Coria
  • Tridas Mukhopadhyay
  • Amir Yaron

In this paper we investigate how well banks manage their reserves. The optimal policy takes into account expected foregone interest on excess reserves and penalty costs for going below required reserves. Using a unique panel data-set on daily clearing house settlements of a cross-section of Mexican banks we estimate the deposit uncertainty banks face, and in turn their optimal reserve behavior. The most important variables for forecasting the deposit uncertainty are the interbank fund-transfers of the day, certain calendar dates, and the interest differential between the money market rate and the discount rate - a measure reflecting the bank's opportunity cost of money holdings. For most banks the model's prediction accord relatively well with the observed reserve behavior of banks. The model produces reserves costs that are significantly smaller relative to the case when reserves are set via simple rule of thumb. Furthermore, alternative motives for holding reserves (such as liquidity and reputation effects) do not seem to be the explanation for why certain banks hold relatively large reserves.

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File URL: http://www.nber.org/papers/w9388.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9388.

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Date of creation: Dec 2002
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Publication status: published as Jallath, Eduardo, Tridas Mukophdyay, and Amir Yaron. "How Well Do Banks Manage Their Reserves?" Journal of Money Credit and Banking 37, 4 (2005): 623-644.
Handle: RePEc:nbr:nberwo:9388
Note: AP ME
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  1. Bartolini, Leonardo & Bertola, Giuseppe & Prati, Alessandro, 2001. "Banks' reserve management, transaction costs, and the timing of Federal Reserve intervention," Journal of Banking & Finance, Elsevier, vol. 25(7), pages 1287-1317, July.
  2. Richard D. Cothren & Roger N. Waud, 1991. "On the Optimality of Reserve Requirements," NBER Technical Working Papers 0101, National Bureau of Economic Research, Inc.
  3. James A. Clouse & Douglas W. Elmendorf, 1997. "Declining required reserves and the volatility of the federal funds rate," Finance and Economics Discussion Series 1997-30, Board of Governors of the Federal Reserve System (U.S.).
  4. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
  5. James Tobin, 1956. "Liquidity Preference as Behavior Towards Risk," Cowles Foundation Discussion Papers 14, Cowles Foundation for Research in Economics, Yale University.
  6. Jacob A. Frenkel & Boyan Jovanovic, 1978. "On Transactions and Precautionary Demand For Money," NBER Working Papers 0288, National Bureau of Economic Research, Inc.
  7. Craig Furfine, 1998. "Interbank payments and the daily federal funds rate," Finance and Economics Discussion Series 1998-31, Board of Governors of the Federal Reserve System (U.S.).
  8. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
  9. Angelini, Paolo, 1998. "An analysis of competitive externalities in gross settlement systems," Journal of Banking & Finance, Elsevier, vol. 22(1), pages 1-18, January.
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