The Fed also does not want banks borrowing at the discount rate too often. For this reason, most banks borrow at the federal funds rate of interest, which is typically slightly higher than the discount rate and does not invite any scrutiny. Banks have had to turn to other sources of funds as their customers have reduced the amount of balances they maintain in checkable deposit accounts, putting more money in stocks, bonds or other assets, especially mutual funds that pay higher rates of return. Consequently, banks have had to increasingly raise funds through nontransactions deposits or borrowings on which they have to pay competitive market interest rates. As this is a more costly way to raise funds, banks have passed these costs along to their checkable deposit account customers in the form of minimum balance requirements, ATM fees, etc.
Loans are riskier than government securities.
One way to reduce the risk of a portfolio of assets is to diversify into less risky investments such as government bonds. Banks hold reserves largely because they are required to, but also to avoid unnecessarily costly borrowing. See the lecture notes for week 10 for the details of this process. The complete model of money creation allows for the possibility that the public holds some currency and that banks hold some excess reserves, so that there are leakages of funds from the banking system. Using the more complete money multiplier that we calculated in part a, we can figure out what happens at the end of the multiple expansion of deposits process.