Question

Why would a bank own government securities

Answer 1

They are lending money - bonds are loans

Bonds pay interest. Thus they are lending and getting a return. Obviously some bonds pay better rates than others depending on the bond. Bonds are also very convenient, compared to traditional lending, finding customers, organizing repayment etc. A bank can buy a lot of bonds at once, and these will come already with a credit rating. Much easier than typical high street lending.

Bonds are liquid

Bonds are also very liquid. Many debts a bank has are not very liquid and would take time to prepare for sale. However they can easily sell a bond in a day and get cash for that bond. And unlike physical gold, bonds are very portable and pay interest without storage costs. Thus they act as a store of value.

Investment banks trade bonds

Many investment banks will also own bonds as part of their general trading operations. They buy and sell bonds on a daily basis and thus will own lots of bonds as part of these operations.

No trust

Should a bank lack trust in their own economy, they may decide to buy government bonds instead of lending. Lending to a government is deemed risk free lending. Thus no capitol is needed in case of default.

There are rules

There are regulatory reasons why a bank may have to hold bonds.

Banks can not lend out all their money, they have to have a store of cash on hand to pay out daily deposits. Now reserve requirements vary depending on the jurisdiction of how much cash to have on hand. But one way of having the cash on hand could be to have the money in very stable investments such as government bonds.

Banks also have to hold large volumes of liquid assets – those which can be sold immediately if need be – which include government bonds.

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may be confusing traditional commercial banks, e.g. Bank of America, Wells Fargo, etc., and central banks, e.g. the Federal Reserve, European Central Bank, etc. Central banks are pseudo-government institutions and are the drivers of monetary policy.

When central banks buy government bonds, money supply increases as the bond sellers exchange their bonds for cash that then re-enters the money supply.

Furthermore, when central banks buy government bonds, interest rates decrease, all else being equal. Increased demand for bonds drives up the price of bonds, which in turn decreases the yield (loosely, interest rate) on bonds.

The relationship between bond prices and yields can sometimes be confusing, so I’ll provide a simple example. Bonds are comprised of a principal component (a.k.a. face value) and a coupon component. For example, let’s say there is a bond with a $1,000 face value with a $50 coupon that gets paid annually. If you buy this bond for $1,000, then the $50 coupon represents a 5% yield (50/1000). However, if the bond price increases to $1,010 (say, due to increased demand from central banks), the yield then decreases to 4.95% (50/1010)