THE VIEW FROM AUGUST—ARE CASH RESERVES INEFFICIENT?

THE VIEW FROM AUGUST—ARE CASH RESERVES INEFFICIENT? I have posted previously on the low level of reserves that investment banks and commercial banks have been holding. An article in August in the Economics Focus section of the Economist presented a contrary view: that capital reserves are inefficient. The article describes a paper which had been presented to the annual Jackson Hole meeting of central bankers. The paper proposed a form of capital insurance for banks in place of reserves. The proposal created a “buzz” at the meeting. The article describes the premise of the paper: for banks to hold more capital “goes against shareholders’ interests, because it results in a lower return on equity. This ultimately hurts economic growth because capital is diverted from projects that might have higher returns.”