ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -The amount of excess reserves is equal to the total reserves reduced by the required reserves. Holding excess reserves leads to the opportunity cost of investing the cash for higher returns.

Detailed explanation-2: -Excess reserves are a safety buffer of sorts. Financial firms that carry excess reserves have an extra measure of safety in the event of sudden loan loss or significant cash withdrawals by customers. This buffer increases the safety of the banking system, especially in times of economic uncertainty.

Detailed explanation-3: -The Fed has created trillions of dollars of excess reserves to the account of member banks. One frequently reads that the banks are not lending out those reserves, which is bad for the economy. But banks cannot lend out reserves. Only the Fed can create or destroy reserves.

Detailed explanation-4: -As described above, a bank holding excess reserves in such an environment will seek to lend out those reserves at any positive interest rate, and this additional lending will decrease the short-term interest rate.