Answer · confidence: partial
Does borrowing demand or bank reserves limit how much money banks create?
Research question: What empirical evidence (loan, deposit and reserve data over time) tests whether loan demand or reserve supply constrains deposit creation, and what do the findings show?
The records show that a 1941 newspaper account described reserves held well above legal requirements as the most important factor, which with light loan demand allowed huge credit expansion 8. Euro area data from 1998-2012 show loans and deposits each respond positively to shocks in the other, and the loan response to a deposit shock is stronger than the reverse, which the authors read as deposit funding mattering for loan supply 710. A 2006 study found state loan growth becomes less sensitive to federal funds rate changes as affiliated banks gain loan market share, indicating financial constraints affect equilibrium lending 9. The facts do not directly test loan demand against reserve supply in a single framework, and the newest fact is from a 2017 study covering 1929-1938 data, so the evidence is roughly nine years old and dated relative to October 2026 14.
Checked 2026-10-21. Only documented and supported facts are used.
Dig deeper on this questionSources
[1] documented
Banks in New York City, a central reserve city, were legally required to hold 13 percent of net demand deposits as reserves.
"Banking law required banks in a central reserve city to hold 13 percent of net demand deposits as reserves."Deposit Insurance and Depositor Monitoring: Quasi-Experimental Evidence from the Creation of the Federal Deposit Insurance Corporation (2017)
[2] supported
Banks in reserve cities like Albany and Buffalo were required to hold 10 percent of deposits as reserves, which could be held as cash, Fed deposits, or deposits in central reserve city banks.
"Banks in reserve cities had to hold 10 percent of deposits as reserves, but could hold those reserves either as cash in their vaults, deposits at the Fed, or deposits in banks in central reserve cities."Deposit Insurance and Depositor Monitoring: Quasi-Experimental Evidence from the Creation of the Federal Deposit Insurance Corporation (2017)
[3] documented
Country banks outside of reserve cities were required to hold 7 percent of net demand deposits as reserves.
"Banks outside of reserve cities were collectively called country banks. These banks had to hold 7 percent of net demand deposits as reserves"Deposit Insurance and Depositor Monitoring: Quasi-Experimental Evidence from the Creation of the Federal Deposit Insurance Corporation (2017)
[4] documented
The cash-deposit ratio for banks rose from 0.13 to 0.21 after 1935 as banks accumulated large cash reserves.
"The cash-deposit ratio rose from 0.13 to 0.21 as banks accumulated large cash reserves after 1935."Deposit Insurance and Depositor Monitoring: Quasi-Experimental Evidence from the Creation of the Federal Deposit Insurance Corporation (2017)
[5] documented
Between 1929 and 1935, the quantity of preferred deposits tripled while the total assets of the groups required to hold them fell, suggesting regular depositors shifted funds into preferred deposits during the financial crises.
"Between 1929 and 1935, the quantity of preferred deposits tripled. In this same period, the total assets of the required groups fell, many by more than half. It seems unlikely that their holdings of bank deposits tripled during this period. Thus, it is likely that some regular depositors shifted funds into preferred deposits during the financial crises in New York in 1931 through 1933."Deposit Insurance and Depositor Monitoring: Quasi-Experimental Evidence from the Creation of the Federal Deposit Insurance Corporation (2017)
[6] supported
Affiliated bank loan growth is less sensitive to changes in the federal funds rate, which the study uses to isolate exogenous variation in bank financial constraints.
"I demonstrate that affiliated bank loan growth is less sensitive to changes in the federal funds rate and that affiliated banks are better able to smooth insured deposit outflows by issuing uninsured debt."New Evidence on the Lending Channel (2006)
[7] supported
A panel VAR on monthly euro area data finds a significant two-way interaction: loans and deposits each respond positively to shocks in the other.
"both loans and deposits respond significantly positive to shocks in the other variable"A macroprudential approach to address liquidity risk with the loan-to-deposit ratio (2014)
[8] supported
Bank reserves held well above legal requirements were described as the most important factor, and with light loan demand they were enough to allow huge credit expansion.
"As loan demand is relatively light and as gold—the basis for credit supply—continues to flow to the United States, such reserves remain at levels sufficient to allow huge credit expansion."Image 40 of Evening star (Washington, D.C.), January 1, 1941
[9] supported
State loan growth becomes less sensitive to changes in the federal funds rate as the loan market share of affiliated banks increases, indicating that financial constraints affect equilibrium lending.
"state loan growth also becomes less sensitive to changes in the federal funds rate as loan market share of affiliated banks increases"New Evidence on the Lending Channel (2006)
[10] supported
The loan response to a deposit shock is stronger than the deposit response to a loan shock, which the authors read as evidence that deposit funding matters for loan supply.
"The response of loans to a shock in deposits is stronger than vice versa, underlining the importance of deposit funding for loan supply."A macroprudential approach to address liquidity risk with the loan-to-deposit ratio (2014)
[11] supported
Interest-rate shocks produce significant negative responses in both loans and deposits, and deposits fall even though deposit rates decrease, which the authors attribute to risk motives dominating price incentives.
"We also find significant negative responses of loans and deposits to a shock in interest rates"A macroprudential approach to address liquidity risk with the loan-to-deposit ratio (2014)