econintersect.com
       
  

FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.



posted on 11 July 2016

How Have High Reserves And New Policy Tools Reshaped The Fed Funds Market?

from Liberty Street Economics

-- this post authored by Gara Afonso and Sam Stern

Over the last decade, the federal funds market has evolved to accommodate new policy tools such as interest on reserves and the overnight reverse repo facility. Trading motives have also responded to the expansion in aggregate reserves as the result of large-scale asset purchases. These changes have affected market participants differently since, for instance, not all institutions are required to keep reserves at the Fed and some are not eligible to earn interest on reserves.

Differential effects have changed the profile of participants willing to borrow and lend in this market, and this shift provides an opportunity to study how unconventional policy actions shape participant incentives. In today's post, we take a detailed look at regulatory filings to identify the main players in today's fed funds market and understand how their roles have evolved.

Measuring the size of the fed funds market has been challenging traditionally. Practitioners and researchers have resorted to regulatory filings to estimate the amount of fed funds sold and purchased at quarter-ends. On March 1, the New York Fed began publishing aggregate data on fed funds volume (see announcement), which will make these data easily accessible for future research.

To measure historical market size, we aggregate data from quarterly regulatory filings to the highest level of each organization to avoid double-counting activity within the same institution. Regulatory filings include quarter-end fed funds activity by: 1) domestic and foreign bank holding companies (BHCs) and thrift holding companies (FR Y-9C); 2) independent commercial banks and savings and loan associations (thrifts) (FFIEC 031/041); 3) branches and agencies of foreign banking organizations (FBOs) (FFIEC 002); and 4) Federal Home Loan Banks (SEC Form 10-Q).

Some fed funds participants did not file regulatory reports over the last ten years. Prior to 2012, not all thrifts were required to file the FR Y-9C or FFIEC 031/041. Earlier filings are only available for a type of thrift, the state savings banks, which file the FFIEC 031/041 and comprise about one third of all thrifts. We are also missing information on Freddie Mac and Fannie Mae since their regulatory filings report combined fed funds and repo activity. This has more of an impact on lending volumes before 2010 since financial statements indicate that Freddie Mac and Fannie Mae reduced their presence in the market by 2011 and are currently inactive.

How "big" is big?

As of the end of 2015, borrowing in the fed funds market reached $56 billion, a big number to be sure, but only about a fourth of its size ten years ago and down from a peak of $280 billion in the first quarter of 2008. The main decline in fed funds volume occurred in late 2008 as the level of reserves in the United States rose to unprecedented levels (see chart below). As excess reserves increased, the need to borrow fed funds to meet reserve requirements and to clear balances gradually disappeared and many participants exited the market.

Fed funds purchased and reserve balances

Over the last two years, the market has stabilized at around $50 billion on quarter-ends. Data published by the New York Fed show a sharp drop in daily volumes from an average of $69 billion in March to $50 billion at the end of the first quarter. This is consistent with incentives to reduce liabilities at quarter-end to meet regulatory requirements such as the Liquidity Coverage Ratio. This quarter-end effect and its impact on fed funds rate volatility was analyzed in a recent Liberty Street Economicspost by Alex Entz, John McGowan, and Asani Sarkar.

Who's who in fed funds?

As with any credit market, the fed funds market reflects the interaction of two sets of participants: those looking to borrow funds and those interested in lending. The chart below shows that the key borrowers are FBOs followed by U.S. and foreign BHCs. The market shares of fed funds borrowers remained fairly stable until 2013. In the last two years, the market share of FBOs has approached 65 percent due mostly to a drop in BHC borrowing. Stand-alone commercial banks and thrifts (not affiliated with a holding company) continue to play a limited role in the market.

LSE_2016_fed-funds-market_afonso_ch3_art

The composition of lenders, by contrast, has changed significantly. Federal Home Loan Banks have become the main supplier of fed funds, almost doubling their market share from 52 percent in 2008 to over 80 percent in 2015. This change reflects the effect of interest on excess reserves (IOER) and elevated excess reserves. IOER raises the opportunity cost of lending for eligible institutions such as BHCs, commercial banks, and FBOs, while institutions not eligible - such as Federal Home Loan Banks - still find lending below the IOER rate profitable. High excess reserves reduce demand for borrowing for funding purposes, making transactions above IOER uncommon, and IOER-eligible institutions less interested in lending.

Foreign participation in the fed funds market has also shifted since the crisis (see chart below). Ten years ago, the borrowing side of the market was split fairly evenly between domestic and foreign entities. Today, foreign borrowers account for almost 70 percent of the fed funds purchased. High excess reserves as well as regulatory requirements, including the change in the calculation of the Federal Deposit Insurance Corporation's deposit insurance fee, have made fed funds borrowing less attractive for some domestic entities. The large presence of foreign borrowers also reflects constrained access to dollar liquidity that foreign institutions face. A recent paper by Acharya, Afonso, and Kovner studies this liquidity constraint around the asset-backed commercial paper market freeze during the financial crisis and shows that foreign banks with limited access to dollar liquidity charged higher rates to corporations on their syndicated dollar loans. On the lending side, domestic institutions are almost the only players nowadays, with a market share of over 95 percent. This shift is mostly explained by FBOs and foreign BHCs exiting the market.

LSE_2016_fed-funds-market_afonso_ch2_art

Over the last ten years, the fed funds market weathered the financial crisis of 2007-09, and a new regulatory regime that introduced novel monetary policy tools. Participants have adapted to these changes and formed a market led by Federal Home Loan Banks selling to FBOs and foreign BHCs in need of dollar funding. This period provides us with an opportunity to study how unconventional policy actions shape participant incentives in a market key to monetary policy implementation.

Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Source

http://libertystreeteconomics.newyorkfed.org/2016/07/how-have-high-reserves-and-new-policy-tools-reshaped-the-fed-funds-market.html


About the Authors

Afonso_garaGara Afonso is a research officer in the Federal Reserve Bank of New York's Research and Statistics Group.

Stern_samSam Stern is a senior research analyst in the Research and Statistics Group.

>>>>> Scroll down to view and make comments <<<<<<

Click here for Historical News Post Listing










Make a Comment

Econintersect wants your comments, data and opinion on the articles posted.  As the internet is a "war zone" of trolls, hackers and spammers - Econintersect must balance its defences against ease of commenting.  We have joined with Livefyre to manage our comment streams.

To comment, using Livefyre just click the "Sign In" button at the top-left corner of the comment box below. You can create a commenting account using your favorite social network such as Twitter, Facebook, Google+, LinkedIn or Open ID - or open a Livefyre account using your email address.



You can also comment using Facebook directly using he comment block below.





Econintersect Contributors


search_box

Print this page or create a PDF file of this page
Print Friendly and PDF


The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.


Take a look at what is going on inside of Econintersect.com
Main Home
Analysis Blog
The Theory of the Monetary Circuit: A Critique
The Expected Effects of Petitions to Improve the Monetary System
News Blog
August 2016 Median Household Income Has Declined From The Beginning Of The Year
August 2016 Pending Home Sales Index Declines?
24 September 2016 Initial Unemployment Claims: Rolling Averages Continue to Improve.
Third Estimate 2Q2016 GDP Revised Upward. Corporate Profits Down.
The Terrorist Networks At Our Fingertips
Infographic Of The Day: Dubai Interesting Statistics And Facts
Early Headlines: Asia Stocks Up, Oil Surges, OPEC Cuts Production, Student Loan Woes Mount, Trump Still Close, Aleppo Hospitals Bombed, Huge Wind Storm In Oz And More
The World's Most Sustainable Cities
Big Sam In Bad Company
Other Ways To Spend Your AirPod Budget
Crashing Space Station Shows Why China Must Start To Collaborate In Orbit
NFL Edges Towards A Full House In London
What We Read Today 28 September 2016
Investing Blog
Will Deutsche Bank Survive?
Banks Of Absurdity
Opinion Blog
The Federal Reserve Note
Trump, Trade And Taxes
Precious Metals Blog
War On Cash Turns To $20, $50, And $100 Bills
Live Markets
29Sep2016 Pre-Market Commentary: US Markets Expected To Open Lower, GDP Higher, Unemployment Lower, US Dollar Higher, Crude Prices Steady And Higher
Amazon Books & More






.... and keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government



Crowdfunding ....






























 navigate econintersect.com

Blogs

Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day
Weather

Newspapers

Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government
     

RSS Feeds / Social Media

Combined Econintersect Feed
Google+
Facebook
Twitter
Digg

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution

Contact

About

  Top Economics Site

Investing.com Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2016 Econintersect LLC - all rights reserved