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by pishpash
1201 days ago
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Reserves are but one tool in the arsenal and it's also for tightly managing the maximum leverage. If all your assets are not cash-equivalent and they fluctuate in value then there is no maximum leverage that can be guaranteed a priori and there is operational risk. |
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Suppose your assets are 50 dollar reserves and 50 dollar investments.
The liability side of your balance sheet is 20 dollars of equity and 80 dollars deposits. For a leverage ratio of 1:4.
If the investments drop 10 dollars in value (to 40 dollars), your leverage ratio goes to 1:8.
If the investments drop 20 dollars in value (to 30 dollars) your leverage ratio goes 1:infinity.
If your investments drop below 30 dollars (say to zero), you are insolvent.
Yes, reserves are a tool that banks can use. But that doesn't mean that legal minimum reserve requirements are a good idea.