What are Net Borrowed Reserves?
Net borrowed reserves are a measure of the difference between what a bank has borrowed from the Federal Reserve and the cash reserves it holds above the required minimum. The opposite of net borrowed reserves is free reserves.
The formula for net borrowed reserves is:
Net Borrowed Reserves = Borrowed Reserves - Excess Reserves
How Do Net Borrowed Reserves Work?
Banks that accept deposits are required to have a certain amount of cash on hand at all times, called reserves. If a bank does not have enough cash on hand on a given day, it might borrow what it needs from the Federal Reserve.
For example, let's assume that XYZ Bank borrowed $400,000 from the Fed and has $500,000 in excess reserves. Using the formula above, XYZ Bank's excess reserves are:
$400,000 - $500,000 = -$100,000
The Federal Reserve releases net borrowed reserve data every week. Net borrowed reserves are often expressed as a negative number.
Why Do Net Borrowed Reserves Matter?
Banks usually incur net borrowed reserves when they are getting ready to lend more or because the bank thinks federal monetary policies might tighten. When the Fed tightens its monetary policy, it usually forces banks to borrow a larger fraction of their required reserves. In either case, net borrowed reserves rise. However, though it may do so opportunistically, a bank can also lean too heavily on the Fed via net borrowed reserves and essentially put itself in a position where it must borrow reserves from the Fed in order to keep lending.
Net borrowed reserves can be used to predict interest rate increases. An increase in net borrowed reserves usually means that demand for loans is high. Put another way, if banks have lent more money than is covered by their reserves, interest rates will tend to rise.