This post is very similar to my previous list of ways in which reserves can leave the banking system, but here I'm not worrying about what's inside or outside the banking system, which greatly simplifies matters. Also keep in mind that the titles to both this post and the prior one are technically incorrect and misleading: by definition reserves are base money INSIDE the banking system, so they can't go anywhere outside of it. Basically there's only three places reserves (really the base money that makes up the reserves) can go (not making a distinction between required and excess reserves here):
- To an entity with a Fed deposit account: Treasury, GSEs, banks (foreign and domestic), foreign central banks, IMF, etc. Note that private individuals and non-bank businesses and organizations don't have Fed deposit accounts, and thus reserves cannot go to them*. Also note that not all banks (for instance) have reserve accounts either.
- Withdrawn from commercial bank customer deposits as paper bills or coins, in which case they cease to be reserves (vault cash). They return to vault cash reserve status once they're redeposited at a bank.
- Back to the Fed (central bank), where they are annihilated**. This is because reserves are liabilities of the Fed***. Electronic reserves are literally annihilated. Paper bills and coins, of course, might not physically be "annihilated" but instead might be sold again (i.e. exchanged for electronic reserves) to another bank. Of course they might also be literally annihilated (i.e. taken out of circulation permanently due to wear and tear).
*Reserves can be credited to the bank where a private individual or non-bank business or organization holds its account with the bank instructed to in turn credit the private non-bank entity's deposit. This happens, for instance, when the Treasury pays a non-bank individual or business for services to the government from its Treasury General Account (TGA) Fed deposit (Note that funds held in the TGA and other non-bank Fed deposits are not technically "reserves" unless they are transferred to banks). It also happens when banks pay for goods or services or when they pay salaries or dividends to private non-banks when the non-bank recipients of the funds hold their deposit accounts at other banks. Note that in both cases, however, Fed deposits don't disappear: they simply move from one Fed deposit to another. Also note that this doesn't mean that banks can "loan out reserves" to non-banks. That's not how commercial bank lending works. I suppose you could claim that reserves could be loaned out indirectly in this manner, but that's always the case, even when there are no excess reserves in the system: when there are no excess reserves in the banking system, commercial banks will simply borrow the needed reserves from the Fed... and the bulk of this borrowing is on a very temporary basis (the exception being required reserves needed, by regulation, to support expanding commercial bank demand deposits). This is because the Fed (central bank) ALWAYS provides the reserves (if needed) to transfer deposits, clear payments, or expand the deposit base. That's one of the main things it's chartered to do! Also, if it didn't, it couldn't control the overnight rate (one of the other main things it does). Thus having excess reserves in the banking system really doesn't make commercial bank loans more likely. Non-bank private entities literally have no use for Fed deposits, which is why they don't need Fed deposit accounts. Non-bank private entities are really only concerned with their bank deposits and physical cash, and that physical cash (most of it anyway) originates from bank deposits (e.g. ATMs).
**Note that both coins and paper bills (notes) are minted by Treasury, but the Fed only pays Treasury the cost of production for the paper bills whereas they pay face value for the coins.
***Coins (as opposed to paper notes) are actually assets of the Fed after being purchased from Treasury at face value (but before being sold to banks): kind of a historical oddity, and I think the basis of the Trillion Dollar Coin idea for skirting the debt limit. The vast bulk of bank reserves (paper notes and electronic reserves) don't show up on the Fed's balance sheet until they are sold to banks, and then they appear as a liability to the Fed (in the case of electronic reserves they of course don't even exist until they are credited to banks!). Of course when coins are sold to banks, they are removed from the Fed's balance sheet (i.e. they are erased as Fed assets).
***Coins (as opposed to paper notes) are actually assets of the Fed after being purchased from Treasury at face value (but before being sold to banks): kind of a historical oddity, and I think the basis of the Trillion Dollar Coin idea for skirting the debt limit. The vast bulk of bank reserves (paper notes and electronic reserves) don't show up on the Fed's balance sheet until they are sold to banks, and then they appear as a liability to the Fed (in the case of electronic reserves they of course don't even exist until they are credited to banks!). Of course when coins are sold to banks, they are removed from the Fed's balance sheet (i.e. they are erased as Fed assets).
