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Tuesday, May 30, 2023

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America’s banks have lost hundreds of billions of dollars

Iit’s easy Learn how money is destroyed in a traditional bank run. Imagine the man in the top hat yelling at the clerk in Mary Poppins. The crowd wants their cash and the bank tellers are trying to deliver it. But when customers fled, staff couldn’t satisfy all comers before the establishment collapsed. Remaining liabilities (and in the case of banks, deposits) were emptied.

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This is not what happens in the digital age. Depositors Fleeing Silicon Valley Bank (SVB) No banknotes and coins. They want their scales connected elsewhere. Nor were deposits written off when the bank collapsed.Instead, regulators committed to SVBcustomers as a whole. While the institution’s collapse is bad news for shareholders, it shouldn’t reduce total deposits in the banking system.

Curiously, deposits in U.S. banks are falling. Assets at commercial banks have shrunk by $500 billion, or nearly 3%, over the past year. This makes the financial system more vulnerable as banks have to shrink to repay deposits. Where did the money go?

The answer starts with money market funds, low-risk investment vehicles that buy short-term government and corporate debt.Those funds flowed in $121 billion last week as SVB Failure. However, the money doesn’t actually go into these vehicles because they can’t take deposits. Instead, the cash that leaves the bank and goes into a money market fund is credited to the fund’s bank account and used to buy the commercial paper or short-term debt that the fund invests in. When a fund uses money in this way, the money goes to the bank account of whichever institution is selling the asset. Flows into money market funds should therefore shuffle deposits around the banking system rather than force them out.

That’s what happened in the past. However, money market funds may take deposits from the banking system through a little-known means: the Fed’s reverse repurchase facility, which was launched in 2013. The plan made seemingly innocuous changes to the plumbing of the financial system, but it could, a decade later, have profoundly destabilizing effects on banks.

In a typical repo transaction, a bank borrows money from a competitor or central bank and deposits collateral in exchange. A reverse repo is the opposite. Shadow banks, such as money market funds, instruct their custodian banks to deposit reserves with the Fed in exchange for securities. The program is designed to help the Fed exit ultra-low interest rates by reducing borrowing costs in the interbank market. After all, why would a bank or shadow bank lend to its peers at a lower rate than the Fed?

But in recent years, the use of the tool has exploded as a result of massive quantitative easing (qe) Banks are flush with cash amid covid-19 and regulatory adjustments. qe Creation of deposits: When the Fed buys bonds from investment funds, banks must intermediary the transaction. Funds’ bank accounts swelled; so did banks’ reserve accounts at the Fed.From the beginning qe Two years later, at the end of 2020, deposits at commercial banks had risen by $4.5 trillion, roughly equal to the growth in the Fed’s own balance sheet.

For a while, banks were able to cope with inflows because the Fed decided at the onset of covid to ease a regulation known as the “supplementary leverage ratio” (SLR). This prevents the growth of commercial banks’ balance sheets from forcing them to raise more capital, allowing them to safely use deposit inflows to boost their holdings of Treasuries and cash. Banks jumped at the opportunity and bought $1.5 trillion in Treasury and agency bonds.Then in March 2021, the Fed allows the waiver SLR invalidated. As a result, banks find themselves stuck in cash they don’t need. They scaled back by borrowing less from money market funds, which opted to park their cash at the Fed instead. These funds have deposited $1.7 trillion overnight in the Fed’s reverse repurchase facility through 2022, up from just a few billion dollars a year ago.

after the fall SVB, small and medium-sized banks in the United States are worried about deposit outflows. The problem is that monetary tightening makes them more likely. Gara Afonso of the Federal Reserve Bank of New York and colleagues find that the use of money market funds rises as interest rates rise because returns adjust faster than returns on bank deposits. In fact, the Fed has raised the rate on overnight reverse repo transactions to 4.8% from 0.05% in February 2022, making it more attractive than the current bank deposit rate of 0.4%. Over the same period, money market funds parked with the Fed through reverse repos — and therefore outside the banking system — rose by $500 billion.

License to print money

For those without a banking license, it is better to keep money in a repo facility than in a bank. Not only are yields much higher, but there is simply no reason to worry about the Fed going bust. Money market funds could actually become “narrow banks”: institutions that back consumer deposits with central bank reserves, rather than higher-return but riskier assets. Narrow banks cannot make loans to companies or provide mortgages. It also cannot go bankrupt.

The Fed has long been skeptical of such institutions, fearing they would undermine banks. 2019 official denial tnb usa, a startup aiming to create a narrow banking, license. The opening of the Fed’s balance sheet to money market funds has raised similar concerns. When the reverse repurchase facility was established, then-New York Fed President Bill Dudley worried that it would lead to “disintermediation of the financial system.” During a financial crisis, it could fuel instability as money drains riskier assets and finds its way onto the Fed’s balance sheet.

There are no signs of a dramatic shock just yet. Right now, the banking system is dealing with a slow bleeding. But deposits are becoming increasingly scarce as the system is squeezed — and small and medium-sized banks in the U.S. could be paying the price.

Read more from our economics column Free Exchange:
Fed kills capitalism to save it (March 16)
Emerging market central bank experiments risk reigniting inflation (March 9)
Case against Google hinges on antitrust ‘mistakes’ (March 2)

Plus: How the Free Exchange column got its name

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