United States: Will central bank reserves soon become insufficient? |Economi Research-BNPParibas

Conjoncture

PDF

Over the past four years, the US Federal Reserve has reduced the surplus central bank reserves that it had

built up under its quantitative easing programme. Over the same period, the Basel 3 banking regulations have,

however, significantly increased banks’ demand for central bank liquidity. Before Basel 3, all reserves in

excess of “required reserves”, in the monetary policy sense of the term, were, justifiably, treated as excess

reserves. Since the new liquidity rules have come into force, only those reserves in excess of the regulatory

constraint may be so treated. Although US banks have so far limited the initial effects of the reduction in

reserves on their liquidity ratios, notably at the cost of increased dependence on the Federal Home Loan

Banks, it would appear that the first signs of tension in liquidity are beginning to show.

p.3

p.10

Monetary policy and aggregate

reserves

Adjustment strategies to the

reduction in reserves

Conjoncture // December 2018

economic-research.bnpparibas.com

Over the past four years, the US Federal Reserve has reduced the surplus central bank reserves that it had built up under its quantitative

easing programme. Over the same period, the Basel 3 banking regulations have, however, significantly increased banks’ demand for

central bank liquidity. Before Basel 3, all reserves in excess of “required reserves”, in the monetary policy sense of the term, were,

justifiably, treated as excess reserves. Since the new liquidity rules have come into force, only those reserves in excess of the regulatory

constraint may be so treated. Although US banks have so far limited the initial effects of the reduction in reserves on their liquidity

ratios, notably at the cost of increased dependence on the Federal Home Loan Banks, it would appear that the first signs of tension in

liquidity are beginning to show.

The six years of quantitative easing conducted by the Fed resulted in an recent years but larger than before the financial crisis. It will reflect the

unprecedented expansion of its balance sheet, and (automatically) in needs of the banking system in terms of reserves and the Committee’s

the amount of reserves held by depository institutions. When the decisions about how to implement monetary policy in the future. In June

programme came to an end, in October 2014, these had peaked at 2017, the FOMC expected to “learn more about the underlying demand

more than USD 2,820 billion, from barely USD 90 billion before the for reserves during the process of balance sheet normalization”.

programme began. Since then, monetary policy measures (repo

transactions, Fed balance sheet reduction programme), combined with

the upward trend in currency in circulation and issues of Treasury bills,

have reduced this stock by more than USD 1,000 billion. Meanwhile, the

Constraints on central bank liquidity have increased significantly as a

result of the Basel 3 banking regulations . Before Basel 3, all reserves

in excess of required reserves, in the monetary policy sense of the term,

were, justifiably, treated as excess reserves . Banks without sufficient

Fed’s balance sheet has shrunk by USD 360 billion since the ending, a

reserves to meet the minimum requirement had to borrow from the

year ago, of the full reinvestment of maturing debt in its securities

central bank (open market operations) or from other banks on the Fed

portfolio. Now the Fed’s balance sheet and bank reserves stand at

Funds market. But demand for reserves at the central bank has

USD 4,150 billion and USD 1,760 billion respectively, which are

historically high levels by pre-crisis standards.

increased as a result of Basel 3 (Pozsar, 2016 ). Since the introduction

of the Liquidity Coverage Ratio (LCR), banks have been required to

Even so, there is some debate about the desirable level over the long hold reserves (or more generally high-quality liquid assets) not only in

term of the Fed’s balance sheet and reserve balances. The Federal proportion to the deposits registered on their balance sheets but more

Open Market Committee (FOMC) has not provided detailed targets in broadly in proportion to their debts falling due within 30 days . Reserves

this area. It has simply indicated that under the Fed’s slimming at the central bank may therefore exceed the volume required under

programme “securities holdings will continue to decline in a gradual and monetary policy (required reserves) but nevertheless be insufficient with

predictable manner until the Committee judges that the Federal a view to the overall liquid asset requirement. As has been highlighted

Reserve is holding no more securities than necessary to implement by Randal Quarles , Vice Chair for Supervision at the Fed, the

monetary policy efficiently and effectively ”. The supply of reserve challenge for monetary authorities is now to evaluate the extent to

balances will gradually be reduced to a level “appreciably below” that of

which LCR will affect the total demand for reserves and thus the size of

the Fed’s balance sheet over the long term.

L. Quignon, Basel III, the money multiplier and monetary policy, BNP Paribas,

Conjoncture 13-12, December 2013.

By virtue of the required reserve coefficient, depository institutions must hold

reserves with the central bank equivalent to a proportion of their deposits.

or from non-banks with an account with the Fed

Z. Pozsar (2016), What excess reserves?, Global Money Notes #5, Economic

Research Credit Suisse, April 2016.

See Box 1 for a more precise definition. Some banks are also subject to the

Figures at 21 November 2018.

Addendum to the Policy Normalization Principles and Plans:

Comprehensive Liquidity Analysis and Review (CLAR) liquidity stress tests.

R. Quarles, Liquidity Regulation and the Size of the Fed’s Balance Sheet,

https://www.federalreserve.gov/newsevents/pressreleases/monetary20170614c.

htm

Remarks at Hoover Institution Monetary Policy Conference, May 2018 :

https://www.federalreserve.gov/newsevents/speech/quarles20180504a.htm

Conjoncture // December 2018

economic-research.bnpparibas.com

Simon Potter, Executive Vice President of the Federal Reserve Bank of

New York, recently indicated that for the time being there are no visible

signs of an insufficiency of reserves at the aggregate level . Since the

Variations in central bank deposits are to an extent exogenous, a

function of monetary policy and the financial behaviour of non-bank

agents. We will examine the various non-conventional measures used

by the Fed over the last few years. First, the Fed’s securities purchasing

programme increased aggregate bank reserves (1.1), before the full

reinvestment of maturing debt stabilised them (1.2). Later, repo

transactions (1.3) and finally the ending of the full reinvestment of

beginning of the year the interest rate at which central bank deposits

have traded (the Effective Federal Funds Rate or EFFR) has certainly

risen, taking it close to the Interest on Excess Reserves (IOER) rate.

This increase has not, however, resulted from an increase in demand

for Fed Funds so much as additional issuance of Treasury bills, which

has pushed traditional lenders of Fed Funds (the Federal Home Loan

Banks) towards the repo markets. According to Potter, evidence of a

scarcity of central bank liquidity will only be manifested when there is a

significant increase in lending at above IOER rates on the unsecured

overnight markets, or when there is a clearer day-to-day relationship

between shifts in the IOER-EFFR spread and in the stock of reserves.

maturing debt (1.4) began to reduce aggregate reserves .

The effects. The Fed’s quantitative easing (QE) policy from December

On the scale of the banking system as a whole, trends in central bank

reserves are exogenous, a function both of monetary policy decisions

and of portfolio choices in the non-bank sector (1 part). Over the past

008 to October 2014 consisted of three waves of securities purchases

(

US Treasury debt, agency debt securities and mortgage backed

rst

securities – MBS – issued by the Fannie Mae and Freddie Mac

mortgage guarantee agencies ). This resulted in an expansion of the

ten years, the Federal Reserve has adjusted its supply of reserves

through a range of non-conventional means. The first such resulted in a

considerable increase in supply, with subsequent measures serving to

stabilise and then restrict it. On the margin of monetary policy, the

financial behaviour of non-bank agents has resulted in an increase in

the money circulating in the economy and in deposits from the Treasury

and foreign central banks held at the Fed. Overall, the aggregate

central bank’s balance sheet both in its securities portfolio (on the asset

side) and reserve balances of depository institutions (on the liability side,

Chart 1). Banks’ reserves at the Fed thus moved into a significant

surplus relative to required reserves (the minimum levels in monetary

policy terms). Domestic banks acted as intermediaries for their clients in

QE, with the result that these purchases also contributed to a sharp

_i_n_c_r_e_a_s_e_i_n_d_e_p_o_s_i_t_s_o_n_t_h_e_l_i_a_b_i_l_i_t_i_e_s_s_i_d_e_o_f_b_a_n_k_b_a_l_a_n_c_e_s_h_e_e_t_s13_.

availability of reserves has now been reduced as a result .

The issue of the ‘necessary’ level of reserves is not simple at first sight.

The LCR constraint was introduced in 2015 against a background of

abundant central bank liquidity, which therefore naturally represented a

substantial proportion of portfolios of liquid assets. In the third quarter of

The mechanics. If the banks themselves had sold their securities

portfolios, QE would simply have resulted in a substitution of assets on

their balance sheets (securities against reserves at the Fed), with no net

effect on the size of their balance sheets (Example 1, Figure 1 p.20).

However, between the end of the third quarter of 2008 and the fourth

quarter of 2014, it was mainly US ‘households’ (the household sector

includes hedge funds and private equity funds in US statistics), states

and local government, non-bank financial institutions (notably the GSEs,

2018, after four years of contraction in aggregate reserves, central bank

liquidity still accounted for more than 40%, on average, of liquid assets

under LCR of the eight biggest US banks (2ⁿ^dpart). The adjustment

strategies adopted since 2015 (substitution of liquid securities for

reserves, reduction in the use of short-term market debt) have, so far,

helped offset part of the reduced availability of reserves. Analysis also

shows that American banks are receiving increasing levels of support

from the Federal Home Loan Banks. Although it is hard to say whether

or not reserves are still ‘sufficient’, it does appear that we are seeing the

first signs of pressure on liquidity, albeit outside the Fed Funds market,

which runs contrary to the expectations of monetary authorities.

See also J. Ihrig, L. Mize and G. Weinbach (2017), How does the Fed adjust

its securities holdings and who is affected?, Finance and Economics Discussion

Series, Divisions of Research & Statistics and Monetary Affairs, Federal

Reserve Board, and D. Leonard, A. Martin and S. Potter (2017), How the Fed

changes the size of its balance sheet, Liberty Street Economics, July 2017.

Fannie Mae and Freddie Mac are the two big Government-Sponsored

Enterprises (GSEs) placed under the protection of the US Treasury since

September 2008. C. Choulet., The fate of Fannie Mae and Freddie Mac is not

yet sealed, BNP Paribas, Conjoncture 18-03, March 2018.

S. Potter, US Monetary Policy Normalization is proceeding smoothly, Remarks

at Banque de France, October 2018:

In a previous article we analysed the various reasons why domestic banks

https://www.newyorkfed.org/newsevents/speeches/2018/pot181026

The ability of banks to protect their liquidity ratios is diminished all the more

as the reduction in the Fed’s balance sheet comes against a background of

rising rates. The current increase in long-term interest rates depresses the value

of securities held on bank balance sheets (notably Treasuries), and thus the

value of the stock of liquid assets.

(US-chartered banks and US branches of foreign banks) modified the ‘natural’

effect of QE on their balance sheet, resulting in a shift in the ownership structure

of reserves with the Fed with no equivalent distortion of the structure of

customer deposits on the liabilities side of their balance sheets. C. Choulet., QE

and bank balance sheets: the American experience, BNP Paribas, Conjoncture

15-07, July-August 2015.

Conjoncture // December 2018

economic-research.bnpparibas.com

pension funds and money market funds) and non-residents who Treasury issue automatically increases its debt and its current account

reduced their holdings of Treasury and/or agency securities (Charts 2 with the central bank, at least temporarily (Stage 2, Figure 2).

and 3). As these agents (with the exception of the Government-

Sponsored Enterprises – GSEs) do not have accounts with the Fed,

Reserve balances of depository institutions with the Fed

these transactions transited through bank balance sheets: in settlement

USD bn

Reverse repo operations,

currency in circulation growth

000

500

000

of its purchases (increase of securities as assets on its balance sheet),

the Fed credited the current accounts of banks (increasing excess

reserves of the banks as liabilities for the Fed and assets for the banks)

whilst the banks credited their customers’ accounts (increase in

deposits as liabilities at the banks – Example 2, Figure 1). All other

things being equal, the Fed’s quantitative easing therefore tended to

increase the size of resident bank balance sheets by increasing their

current accounts with the Fed and their liabilities to customers.

Ultimately QE in the US resulted in growth in the monetary base

QE3

1500

QE2

Full reinvestment of maturing

debt halted, Treasury general

account swells

QE1 Extension

000

500

Fed loans to

banks and start

of QE1

14 15

(

narrow money) and also in total money supply .

006

2008

2010

2012

2014

2016

2018

Chart 1

Source: Federal Reserve

Breakdown of Treasuries by holder sector, 2008-2014

The effects. In October 2014, the Fed ended its securities purchasing

programme. In order not to upset the interest rate markets, it

_n_e_v_e_r_t_h_e_l_e_s_s_m_a_i_n_t_a_i_n_e_d_i_t_s_p_r_o_g_r_a_m_m_e1⁶of full reinvestment of

maturing debt and thus stabilised the size of its balance sheet (Chart 4).

Taken in isolation, this approach had no impact on bank reserves at the

Fed.

Change in holdings, % points

50%

20%

of Treasury outstanding

10%

20%

30%

Full reinvestment of maturing Treasuries

-6

Sept. 2008

Dec. 2014

Spread

-8

-10

The mechanics. As it is not authorised to subscribe directly for

Treasury issues, the Fed renewed its portfolio of Treasuries by

swapping maturing for newly issued securities ¹⁷. The maturing of

-40%

Treasuries reduces the value of the securities portfolio in the Fed’s

_a_s_s_e_t_s_a_n_d_t_h_e_T_r_e_a_s_u_r_y_G_e_n_e_r_a_l_A_c_c_o_u_n_t₍_T_G_A₎_h_e_l_d_a_t_t_h_e_F_e_d₁8

Chart 2 Sources: Federal Reserve, BNP Paribas

Breakdown of agency MBS by holder sector 2008-2014

(

Stage 1, Figure 2 p.20). Without new issuance, outstanding Treasury

debt would gradually reduce, as would its account at the Fed. Any new

of MBS outstanding

Change in holding, % points

The monetary base includes notes and coins and reserves at the central bank.

This would have been less notable if only the banks, the GSEs (which have

accounts with the Fed) and non-residents (whose deposits are not included in

money supply) had sold securities. Moreover, second level effects could have

either reduced or amplified the direct effects of QE on money supply. For

example, if a US hedge fund had sold 100 units of securities to the Fed and

invested the additional deposits created in securities issued by a non-resident,

non-financial company, this would have resulted in a reduction of the effect.

Conversely, if a non-resident had sold 100 units of securities to the Fed and

invested the cash received in securities issued by a resident (thus increasing its

deposits), this would have amplified the effect. Liquidity circulating between

agents, who are the final owners of the deposits created by QE, is not directly

identifiable.

10%

-20%

30%

-10

Sept. 2008 Dec. 2014 Spread

-20

-25

Chart 3

Sources: Federal Reserve, BNP Paribas

Begun in August 2010

Non-competitive bids to Treasury auctions

We ignore interest payments, which constitute revenue rather than principal.

Perhaps very temporarily if the funds raised are immediately used to finance

public spending.

Conjoncture // December 2018

economic-research.bnpparibas.com

The Fed's balance sheet

USD bn

Other liabilities

000

500

000

500

000

500

000

500

000

The effects. At the margins of its programme for the full reinvestment of

maturing debt, the Fed has conducted transactions which, whilst not

affecting the size of its balance sheet, reduced banks’ current accounts.

In September 2013, with the aim of regaining control of short-term

Deposits held by GSEs & CCPs

Treasury general account (TGA)

Reverse repo & Term deposit facility

Reserve balances held by banks

Currency in circulation

Total

interest rates , the Fed introduced two tools designed to reduce excess

liquidity: the Term Deposit Facility (TDF) and the Reverse Repurchase

Agreement Facility (RRP facility). In 2015, it also extended its reverse

repo transactions with foreign central banks (FRRP). These measures,

combined with the increase in currency in circulation, the additional

issuance of Treasury bills and new constraints on margin calls from

clearing houses ²², reduced reserves by around USD 570 billion

between October 2014 and October 2017 (Charts 5 and 6). As other

liabilities replaced bank reserves, the Fed’s balance sheet remained

unchanged over this period (Table 1).

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Chart 4

Source: Federal Reserve

Full reinvestment of loan repayments

The mechanics. Unlike the maturing of a Treasury security, the

repayment of a mortgage loan used as an underlying instrument in an

MBS is spread over time and gradually reduces the value of the MBS.

Mortgage holders may also make early repayment due to sale of the

property or a renegotiation or repayment of the debt. The pattern of

repayment of principal and indeed of interest payments is therefore less

predictable. Repayment flows transit through the original lending bank

The Term Deposit Facility (TDF)

The mechanics. This measure consists of offering banks the ability to

convert their reserves into term deposits for a number of days (Figure 4

p.21). This has no effect on the balance sheets of either the central

bank or the banks . Thanks to an attractive yield, the sums converted

reached USD 400 billion in December 2014 and again in February 2015.

Transactions to convert reserves into term deposits have become rarer

since then.

to the holder of the MBS via the MBS issuer (a GSE) .

The repayment by the household reduces its debt and its deposits

(

Stage 1, Figure 3 p.21). The commercial bank (which originated the

loan but no longer carries it on its balance sheet) makes a transfer from

its account with the Fed to that of the MBS issuer (the GSE which

carries the loan on its balance sheet). The bank’s reserves are reduced,

those of the GSE increased. The GSE then transfers the funds to the

account of the investor who holds the MBS (the Fed in this example).

The GSE’s reserves are reduced. Ultimately, the repayment of the loan

results in a reduction in the Fed’s balance sheet, in the bank’s reserves

and in deposits. The full reinvestment of the repayment cancels out

these effects. Subscription for a new loan of a value equivalent to the

repayment made increases the deposits and debts of the household

²¹The unprecedented expansion of banks’ reserves with the Fed depressed

money market interest rates. From 2008, the Fed paid interest on banks’ excess

reserves (0.25%). The interest rate (IOER) serves as a floor for the effective

Fed Funds rate as banks have no interest in lending their central bank reserves

at a rate lower than IOER. However the GSEs, which have accounts with the

Fed but are not able to receive interest on them, continued to lend liquidity at a

rate lower than the IOER and thus dragged interest rates back down again. The

volumes traded on the Fed Funds market remained modest due to weak

demand from the banks.

(

Stage 2, Figure 3). The bank sells the loan to the GSE. This sale

results in a transfer from the GSE’s account to that of the bank. The

GSE issues an MBS secured in part on this loan (Stage 3, Figure 3).

The Fed subscribes to this issue and credits the GSE’s account. After

reinvestment, the value of the Fed’s MBS portfolio and the current

account of the GSE with the Fed are unchanged, as are the commercial

bank’s reserves.

Since February 2014, the biggest clearing houses have been able to hold an

interest bearing account with the Fed. Their deposits are recorded under the

heading “Other reserves with Federal Reserve Banks” alongside GSE reserves.

In order to make them more attractive than at the time of the launch in

September 2013, in October 2014 the Fed opportunistically adjusted the details

of term deposits available to banks under the TDF. Initial offers fell foul of

banking regulations. Following the finalisation of the LCR standard in

September 2014, which indicated that a share of term deposits can be used to

meet the inclusion criteria, provided that early withdrawal is possible, the Fed

announced that from October it would offer 6-, 7-, and 8-day deposits, but this

time with early withdrawal rights. This change allowed banks to make use of the

facility without damaging (or improving) their LCR.

To simplify explanations, we assume that repayment and reinvestment take

place on the same date. We also ignore the transitory effects of repayments and

reinvestment on the account of the Fed’s custodian bank (JP Morgan) and the

effect of interest payments.

Conjoncture // December 2018

economic-research.bnpparibas.com

Tools for draining excess liquidity through Sept. 2017

of its client (Example 2, Figure 5). All other things being equal, on

completion of the transaction the bank’s reserves are reduced.

USD bn

Reserve balances of depository institutions with the Fed

TDF+RRP+FRRP+TGA+GSE & CCP accounts (inv. scale)

USD bn

2900

2700

2500

2300

2100

1900

1700

The Fed balance sheet: from one liability to another

Value

As at

21/11/18

USD billion

03/09/08

From

03/09/08

From

15/10/14

From

18/10/17

Change

USD billion

5/10/14

18/10/17

21/11/18

Fed’s balance

sheet

39.5

+3,578.1

-1

-362.5

4,154.1

of which:

1050

2018

Sources: Federal Reserve, BNP Paribas

2013

2014

2015

2016

2017

Currency in

circulation:

36.7

+459.6

+179.4

+288.9

+127.1

+120.8

-97.4

1,706

250.8

Chart 5

Reverse Repo

(RRP and

FRRP)

The Fed's balance sheet and reserve balances of banks

41.7

₀₀USD bn

Treasury

General

Account

5.6

0.3

+95.8

+7.8

+94.7

+71.1

+121.2

-7.7

317.3

71.5

GSE and CCP

accounts

200

400

600

800

Other

50.7

+19.3

-17.2

-1.8

Bank reserves

4.5

+2,816.2

-565.6

-497.6

1,757.5

Change in bank reserves since Oct. 2014

Table 1

Source: Federal Reserve

1000

1200

1400

Change in the Fed's balance sheet since Oct. 2014

Reserves drained by increasing other liabilities (currency in circulation, TGA,

GSE & CCP deposits, RRP, FRRP & TDF facilities)

The Fed carried out the majority of its reverse repo transactions (via

banks) with money market funds (MMFs), the only organisations with an

014

2015

2016

2017

2018

incentive to take part . On average, between September 2013 and the

end of 2017, some USD 120 billion in cash was ‘loaned’ to the Fed

under RRP; the daily average reached USD 145 billion during 2017.

These transactions resulted in a marked reduction in deposits in MMF

assets (Chart 7, collateral effect of the LCR standard, see below). In

Chart 6

Sources: Federal Reserve, BNP Paribas

Reverse Repo operations (RRP)

The mechanics. This second liquidity reduction measure consists of

conducting reverse repo transactions on Treasuries (sale with obligation

to buy back) at a fixed rate and at capped amounts with an expanded

list of counterparties (banks, primary dealers, GSE and money market

funds). By using this facility a bank or non-bank makes a secured loan

2018, secured lending by MMFs to the Fed fell significantly. Increased

issuance of Treasury bills pushed up the repo rates on the triparty

market, luring GSEs away from the Fed Funds market (see below) and

the MMFs away from the less well remunerated reverse repos of the

Fed (Chart 8).

(

cash against Treasuries) to the Fed. As with security purchases by the

Fed, the repo transaction passes through the balance sheet of a bank

unless the counterparty is a GSE), whether it is the Fed’s final

(

counterparty (Example 1, Figure 5 p.21) or not (Example 2, Figure 5).

As a result of the operation, the size of the central bank’s balance sheet

is unchanged, but the composition of its debt is modified (repo instead

of reserves) and the account of its counterparty is debited. When a bank

enters into a repo transaction with the Fed, the transaction results

simply in an exchange of assets on its balance sheet (repo against

reserves), with no effect on the overall size of its balance sheet

Whilst the interest rate on these operations remains below the IOER rate on

excess reserves, banks have little incentive to participate. The facility might of

course be of interest to those looking for very high-quality collateral to refinance

themselves or meet initial margin requirements. However, at a prudential level,

excess reserves and Treasuries (and repos guaranteed by Treasuries) are

treated equally (receiving the most favourable treatment). Although the RRP

interest rate is similar to IOER for non-banks, the involvement of the GSEs

(notably the Federal Home Loan Banks, see Note 40) is limited for regulatory

reasons. Thus the programme involves mainly (i.e. at more than 80%) money

market funds, giving them a high-quality counterparty and collateral and making

it easier for them to satisfy SEC requirements.

(

Example 1, Figure 5). Where the Fed’s counterparty is a non-bank (for

instance a money market fund), the commercial bank debits the account

Conjoncture // December 2018

economic-research.bnpparibas.com

Repos vs deposits on the balance sheets of MMFs

asset side) and the composition of the Fed’s debt is changed (repo

instead of reserves). When the foreign central bank chooses to sell

securities to increase its deposits (Example 2, Figure 6), the effects are

identical to the previous example with the sole difference that it is the

deposits of the financial clients of the commercial bank (hedge funds for

example) that are reduced, rather than those of the foreign official

sector.

USD bn

200

000

Security repurchase agreements

Deposits

800

600

400

200

Surge in Fed reverse repos

USD bn

700

600

500

400

OR ep vée r ras tei or ne ps u dr ce h ra es ve e ar sg er e er em p eon tds o, no ft w: hich:

RRP (with money market funds)

RRP (avec les fonds monétaires)

2004

2006

2008

2010

2012

2014

2016

2018

Foreign RRP (with foreign officials)

Chart 7

Source: Federal Reserve

Rate structure

Rate in %, end of month

300

100

IOER rate

Effective Federal Funds Rate (EFFR)

Repo rate in the triparty market

Reverse repo rate (RRP)

011

2012

2013

2014

2015

2016

2017

2018

Chart 9

Source: Federal Reserve

The Fed does not publish continuous information on the interest rates

for these transactions. It only provides the average rates for the first

quarter, first half and first nine months of each year when it publishes its

(

unaudited) quarterly financial statements. We have extrapolated

estimates on quarterly yields on the basis of these data. It appears that

these transactions offer a very attractive return, above the rate paid on

RRP and the one-month T-bill yield (Chart 10), such that it encourages

foreign central banks to reduce their holdings of short-dated Treasuries

in order to take full advantage of it (Chart 11). These securities could

have been sold to financial institutions such as hedge funds or private

equity funds whose non-operating deposits are less well remunerated

014

2015

2016

2017

2018

Chart 8

Source: Macrobond

Reverse repo transactions with foreign central banks (FRRP).

The mechanics. The Fed releases relatively little information about

these transactions. Even so, their contribution to reducing excess bank

reserves has been far from negligible for some years now (Pozsar,

(

or even penalised) on the balance sheets of banks (collateral effect of

the LCR standard, see below), or to MMFs that have been required to

increase their exposure to government debt (since the reforms of

016 ). Having doubled between the end of 2014 and the end of 2015,

average outstanding amounts have stood at USD 240 billion since early

016 (Chart 9). As is the case with reverse repos with MMFs, these

014 ).

transactions pass via the balance sheets of commercial banks. When a These transactions resulted in a sort of sterilisation of liquidity in the

foreign central bank has deposits with a resident bank, the transaction current accounts of foreign central banks. In the absence of a reduction

consists simply of an asset swap on its balance sheet (repo for deposits, in the interest rate paid, they will constitute a natural limit to the

Example 1, Figure 6 p.22). The balance sheet of the commercial bank is reduction in the Fed’s balance sheet.

reduced (reduction in deposits on the liabilities side and reserves on the

C. Choulet, US money market funds and US dollar funding, BNP Paribas,

Ecoflash, 16 July 2018.

Z. Pozsar (2016), A tool of their own, The foreign RRP Facilty, Global Money

Notes #4, Economic Research Credit Suisse, February 2016.