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I regularly read that the European Central Bank charges a negative interest rate on money that banks park there. But why would a bank put their money to the Central Bank then? Can't they just keep it in their own bank and not have to pay that negative interest?

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The money has to be parked somewhere

The big issue here is that all money has to be parked somewhere.

Contrary to the popular misconception, there's no possibility to store digital money in your own servers (if we exclude cryptocurrencies) - money is "stored in servers" in the form of accounting records for debt; and we call that "money" because a reputable bank (or in this case, the central bank) acknowledging "here's your account balance - we owe you 123456 money" is pretty much as good as cash because you can easily use it to pay others. Those records of debt, "IOUs" are the thing that can get transferred with electronic wire transfers - but all that inevitably results in money that's "parked" somewhere, a balance in some account with another institution.

What are the alternatives?

If we look at the assets in the balance sheet of a typical bank (and ignore irrelevant classes such as office furniture owned by it), then you can think of them as the following large groups (general accounting would split them differently, but this split is illustrative for this problem):

  • Loans to customers (mortgages, credit cards, leasing, etc) including net receivables
  • Securities (t-bills, bonds, stocks, etc - some of them considered cash equivalent)
  • Longer-than-1-day loans to other financial institutions (deposits with them)
  • Account balances and overnight deposits with other financial institutions
  • Physical cash

So what do you do if you have $100mm extra "cash" in your central bank account, and you want it to not be there? You have to use one of the other alternatives. The first three parts would amount to "getting rid of that money" by buying stuff (bonds/stocks/etc) with it or lending it to someone else.

But if you want to "keep that money", then you have to keep it somewhere. You could keep it at another institution - but other banks aren't likely to give you better conditions than the central bank unless they need cash to fulfil their reserve requirements; if you'd electronically transfer that money to them, what that literally means is that the central bank will take that money (debt) from your account and put that money in their account at the central bank, so the recipient will have to pay the negative interest for that amount at the end of day. So that's not really a viable option.

And the remaining option is to keep that money yourself - which involves withdrawing it as pallets of printed banknotes. It's a possibility (I mean, that's how commercial banks manage their physical cash - by buying/selling it to the central bank or some other bank), but it has certain expenses for transportation and storage. On the other hand, if the central bank rate is negative 0.5%, then that amounts to $14 to store a million dollars overnight. So if you have some extra 10 million remaining there (you'll try to minimize the amount, of course), it's cheaper to just pay the fee instead of sending an armored truck to withdraw it as cash (and bring it back tomorrow when you might need that money for electronic payments).

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    Upvoting the question and this answer because it does a great job of dispelling the (perhaps unintentionally held) myth that actual money can be "electronic" and move digitally. – dwizum Aug 23 at 12:41
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    Dang, I did not realize that the bank cannot store cash in digital form on their own premises. I naively assumed that this was the main point of being a bank, but without crypto currency there is no way to do this in a meaningful way. So of course, electronic money is backed up by somebody else holding the palettes of physical cash. — Thank you very much! – Martin Ueding Aug 23 at 18:17
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    @MartinUeding to be clear, the central bank does get to have purely electronic money, everybody gets to choose between real cash and the central bank. Perks of running the show, I suppose. – mbrig Aug 23 at 20:59
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    AIUI banking mostly works on a 1 day "time step". What the numbers are during the day doesn't normally mater much, it's what the numbers are at the end of each day that normally determines interest and fees. – Peter Green Aug 25 at 0:44
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    @NZD not really. The main reason for overnight deposits is reserve requirements - which are always in the local currency and matched to the business day of the appropriate central bank(s). For GBP there's a single overnight schedule matching UK time even if you're trading from Hong Kong or New York, since all the banks that need GBP o/n because of GBP reserve requirements are UK banks (or UK branches of respective worldwide banks); for USD the o/n market is tied to the closing day of the Federal reserve banks (not where you live) and the settlement is limited to operating hours of Fedwire. – Peteris Aug 26 at 6:45
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Banks are obligated to keep cash in the central bank following reserve requirements.

The reserve requirement (or cash reserve ratio) is a central bank regulation employed by most, but not all, of the world's central banks, that sets the minimum amount of reserves that must be held by a commercial bank. The minimum reserve is generally determined by the central bank to be no less than a specified percentage of the amount of deposit liabilities the commercial bank owes to its customers.

[...]

...the higher the reserve requirement is set, the less funds banks will have available to lend out

When central bank wants to fight deflation, it will set negative interest rate, thus decreasing amount of money banks have.

In a sense, "negative interest rate" is a tax on the banks, but instead of going to the government, tax goes to central bank (taken out of circulation), which decreases total cash in the economy.

I don't understand in which conditions banks would keep more money than required by reserve requirement while paying fee for that (see Negative interest on excess reserves ) but answer by Peteris addresses that

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    "in which conditions banks would keep more money than required by reserve requirement while paying fee for that" - in conditions where that fee is cheaper than alternatives; all the incoming money from other institutions (e.g. cover for customer payments) in general will arrive as funds at the central bank accounts, so if they don't want to keep it there they have to keep it somewhere else (which will usually have similar rates) or hold it themselves as cash; and 0.5%/365 overnight interest can easily be cheaper than taking out, transporting, storing and returning huge amounts of cash. – Peteris Aug 23 at 5:42
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    @Peteris: By "cash", do you mean printed bank notes? That isn't how money moves between a bank and a central bank. It's an electronic message which costs nothing to send. – Martin Bonner Aug 23 at 8:08
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    @MartinBonner In essence, there's no such thing an electronic message transferring money from your account at the central bank to "you". If some other bank transfers money to "your bank" what that actually means is a credit to your bank's account at the central bank or federal reserve in USA. If you want to get money "out" of that system (to avoid negative interest) then you either get rid of it by buying something (e.g. bonds) or lending it to someone else or withdraw it as physical cash. Which is always a possibility, but has some costs. – Peteris Aug 23 at 8:59
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    @Peteris this sounds like the basis of a great answer to this question. In essence "All money in a system is either eventually parked at the central bank or in cash, a bank cannot stash actual digital money in their own servers" with some references ? – Falco Aug 23 at 10:39
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    @Falco I tried to do so, but didn't have much time, perhaps it needs some corrections/clarifications. – Peteris Aug 23 at 11:26

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