Secondly, such transactions seem inappropriate against a background of excess collateral[16]. Reducing their yields (or introducing a cap) would help redirect foreign central bank liquidity towards Treasury securities.
Above all, in a situation of scarcity of central bank money, it is counter-productive to offer this facility. The Fed’s systems result in the daily injection of at most between USD 200 bn and USD 250 bn into banks’ current accounts, through repo transactions[17], whilst at the same time destroying nearly USD 300 bn in reserves each day through reverse repo deals with foreign central banks.
Reducing the scale of these transactions would allow the Fed to free up space on its balance sheet for banks (without expanding its balance sheet further) whilst it defines more precisely its needs in “organic growth”, according to the Fed’s terminology.
[1] C. Choulet (2018), Will central bank reserves soon become insufficient?, BNP Paribas, Conjoncture, December 2018
[2]A repo transaction – the temporary disposal of securities – can be considered, from an economics viewpoint, as a collateralised loan (cash against securities): from the point of view of the lender of the cash it is a reverse repurchase agreement; from that of the borrower of the cash it is a repurchase agreement. The repurchase agreement incorporates an undertaking to repurchase the security at a given point in time for an agreed price. The interest rate, or repo rate, is a function of the difference between the sale and repurchase prices. The Fed defines the operation as a function of its effect on its counterparty. Thus from the Fed’s point of view, a repo is similar to a collateralised loan and recorded as an asset whereas a reverse repo is a liability. The repo markets are the main source of overnight refinancing for financial institutions in the USA.
[3]The SOFR is a broad measure of the cost of borrowing cash overnight collateralised by Treasury securities on the tri-party repo market and on markets cleared through the Fixed Income Clearing Corporation (GCF repo and bilateral market). Volumes traded on these markets vary between USD1,000 bn and USD1,250 bn per day. As part of the reform of benchmark rates, it has been selected as an alternative to LIBOR to come into use by the end of 2021.
[4]Credit cooperatives
[5]C. Choulet (2019), Primary dealers absorb nearly 40% of the Fed’s net sales of Treasuries, BNP Paribas, Chart of the Week
[6]Mortgage guarantee and refinancing agencies
[7]Initially, subscription for securities by primary dealers results in a reduction in their credit balance with BONY, which transfers cash from its account with the Fed to that of the Treasury (to settle the purchases made by primary dealers). In a second phase, when a primary dealer puts securities into a repo with a bank (or one of its clients), there is a transfer of cash from the counterparty bank’s account with the Fed to BONY. The net result is that banks’ reserves with the Fed are reduced and the Treasury’s account increased.
[8]C. Choulet (2019), Pressure on central bank liquidity is going undetected, BNP Paribas, Eco Flash, April 2019
[9]In Q2 2019, central bank reserves represented 33% of HQLA at the 8 biggest US banks, from 43% in Q3 2017 (before the Fed’s balance sheet reduction).
[10]These transactions consist, for eligible counterparties (the primary dealers in this instance), in selling securities (Treasury debt securities, debt securities and mortgage-backed securities issued by the mortgage guarantee agencies) to the Fed with an obligation to buy them back at a certain point. From an accounting point of view, the securities remain on the balance sheets of the Fed’s counterparties. The Fed records the repo on its balance sheet as a credit to primary dealers and credits the banks’ current accounts (central bank reserves), whilst the banks credit the deposit accounts of their clients. All other things being equal, on completion of the transaction banks’ reserves with the central bank are increased.
[11]https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policy-implementation/repo-reverse-repo-agreements/repurchase-agreement-operational-details
[12]By borrowing an additional USD 381 bn on the fixed income markets in the fourth quarter
(https://home.treasury.gov/news/press-releases/sm743)
[13]Z. Pozsar (2019), Design options for an o/n repo facility, Global Money Notes #25, Credit Suisse Economics, September 2019, 9.
[14]As foreign central banks do not have accounts with the Fed, these transactions transit through bank balance sheets. In return for the reverse repo operation with a foreign central bank, the Fed reduces the stock of reserves of the intermediary commercial bank, which in turn debits the dollar current account of its client (the foreign central bank). The Fed records the foreign central bank’s debt on its balance sheet (reverse repo) but reduces its debt to the banking system
(reserves) by the same amount, such that the transaction has no effect on the size of its balance sheet.
[15]Whilst the Fed provides detailed information on repo and reverse repo transactions with private counterparties (volumes demanded, range of rates offered), it is much less forthcoming regarding reverse repo transactions entered into with foreign central banks. It 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 quarterly estimates on the basis of these data.
[16]Although between 2015 and 2016 these operations helped ease tension in the yields on Treasuries (nudging foreign central banks towards Treasuries at a time when money market funds were forced to increase their exposure to government debt), under current circumstances (high issuance levels of short-dated Treasuries) they look unjustified.
[17] The maximum offered on daily overnight operations (USD 100 bn) and the three 14-day term operations (USD 150 bn).