Diminishing returns for the banks

 

The excess reserves are reserves not needed for collateral regulations. It earns a low rate, it is regulated cash. But the less deposits on reserves, the higher the bond tax, and banks have bonds as collateral. This is a diminishing return scenario, bounded on both sides.

Private shadow contracts can utilize this cash as a promise to pay later. The central bank is none the wiser. The arbitrage happens because the Fed has become tax collector to the regulated banks.  There is a distortion effect with unlegislated taxes, the tax avoidance is an arbitrage point, a point not stable by mark to market.  Government legislation is a kind of mark to market.