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Why Commercial Banks Held Excess Reserves: The Japanese Experience of the Late 1990s

Authors


  • This is a substantial revision of the paper I submitted to the Financial Research Council. I am grateful to Hiroshi Fujiki, Shin-ichi Fukuda, Hideo Hayakawa, Nobuo Inaba, Kazumasa Iwata, Toshiki Jinushi, Keimei Kaizuka, Hiroshi Koyama, Ryuzo Miyao, Hiroshi Nakaso, Kunio Okina, Yoshinori Shimizu, Etsuro Shioji, Shigenori Shiratsuka, Hisashi Tanizaki, Juro Teranishi, Fukujyu Yamazaki, Jyunji Yano, Yukihiro Yasuda, the participants of the seminars at the Bank of Japan and Kobe University, and an anonymous referee for extremely valuable comments and suggestions on early version of the paper. Masayo Kani provided excellent research assistance. This research was partially supported by Grants-in-Aid for Scientific Research 12124207 and 16330038 of the Ministry of Education.

Abstract

We investigated, empirically, why Japanese banks held excess reserves in the late 1990s. Specifically, we pin down two factors explaining the demand for excess reserves: a low short-term interest rate, or call rate, and the fragile financial health of banks. The virtually zero call rate increased the demand for excess reserves substantially, and a high bad loans ratio largely contributed to the increase in excess reserve holdings. We found that the holdings of excess reserves would fall by two-thirds if the call rate were to be raised to its level prior to the adoption of the zero-interest-rate policy, and the bad loans ratio were to fall by 50%.

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