Banks in the Market for Liquidity

Abstract

Banks are unique among financial institutions because they are the cheapest source of liquidity in the economy. Banks choose to hold reserves to facilitate settlement of end-of-day net due to positions arising from payments operations. Money market substitutes for bank liabilities do not escape from the cost of reserves since their issuers lean on banks to provide liquidity. Since the cost of reserves falls on all issuers of less liquid liabilities seeking access to payment services, including non-bank intermediaries, reserves cannot represent a tax on the banking system alone.