Better Than Risk-Free: Do Reserve Premiums Crowd out Bank Lending?

When the Federal Reserve first paid interest on excess reserves (IOER) in October 2008, it presented a choice that banks had not previously faced. Banks could invest capital in precautionary excess reserves and earn a risk-free rate "better than" the treasury rate, or lend and earn a higher, but riskier interest rate. One-stage and two-stage panel estimations show "reserve premiums" are associated with a 6% ($601.5B) reduction in bank lending after accounting for increased lending due to QE. Results support the growing importance of policy discretion as IOER inverted interest rate incentives for counter-cyclical lending to that of cyclical lending.