Executives at the Federal Reserve Bank of New York believe the increase in excess reserves held by banks that received Troubled Asset Relief Program (TARP) funds is a by-product of the program’s extraordinary measures to recapitalize the nation’s financial institutions and provide stability to the sector. Todd Keister is an assistant vice president and James McAndrews is a senior vice president in the monetary and payment studies function of the Federal Reserve Bank of New York’s research and statistics group. In a recent article, “Why Are Banks Holding So Many Excess Reserves?” they wrote:

The level of reserves began to rise following the collapse of Lehman Brothers in mid- September 2008, climbing from roughly $45bn to more than $900bn by January 2009. While required reserves — funds that are actually used to ful?ll a bank’s legal requirement — grew modestly over this period, this increase was dwarfed by the large and unprecedented rise in the additional balances held, or excess reserves.

In the article (download here), the authors explain how a infusion such as TARP’s Capital Purchase Program (CPP) can have a double impact in helping small lenders maintain lending capacity and larger lenders that lend to the small banks increase excess reserves. Nearly every week this year, the Federal Deposit Insurance Corp. (FDIC) shells out millions to cover the losses of failed banks. To date, more than 130 US banks have failed in 2009, creating the greatest strain the FDIC’s deposit insurance fund has ever experienced. Given that, it’s not necessarily a bad thing for a large bank to boost its reserves, if for only a psychology reassurance that the nation’s biggest lenders won’t fail and further compromise the FDIC fund. Moody’s economist Mark Zandi said he believes the banks are “overcapitalized.” Proponents of this theory believe the lenders should be lending more. Last week, President Obama met with the CEOs of the nation’s 12 largest banks and called on them to increase lending. But just because a bank has money to lend, that doesn’t mean businesses and individuals want to take out loans. The banks can’t make people borrow money. Conversely, the argument could be made that the $700bn TARP infusion was too great. After all, former TARP director Neel Kashkari recently admitted to the Washington Post the $700bn was a number that came out of thin air. Write to Austin Kilgore.