Last week, Federal Reserve Vice Chair for Supervision Michael Barr gave a speech entitled, "Supporting Market Resilience and Financial Stability," which suggested that regulators will be taking a harder look at uninsured bank deposits. He states, "[W]e have made important progress since last year's conference. The Securities and Exchange Commission has finalized a rule on central clearing of Treasury transactions, the Treasury Department has instituted a program for buying back less-liquid Treasury securities, and the Office of Financial Research is preparing for its permanent collection of data on non-centrally-cleared bilateral repurchase agreement (repo) transactions, which will support our understanding of this market segment as it evolves."
Barr explains, "In previous speeches, I have talked about the role of the discount window and the standing repo facility (SRF) in supporting both monetary policy implementation and financial stability, noting how important it is that eligible institutions be ready to use these facilities. Today I want to dig into this topic a bit more, including how these tools support monetary policy implementation through appropriate incorporation into liquidity regulations and supervisory practices."
He continues, "When banks exhibit a high degree of substitutability of demand for these assets, money market functioning improves. Let me explain with an example. If a bank sees holding reserves and investing in Treasury repo as near substitutes in its liquidity portfolio, it should lend into Treasury repo markets when repo rates rise above the interest rate earned on reserves. When banks can nimbly adjust portfolios in response to price incentives, the efficiency of reserves redistribution through the system improves, and market functioning is enhanced."
Barr tells us, "In 2021, the Federal Reserve launched the SRF, which, along with the discount window, should help cap upward pressure in repo markets that could spill over into the federal funds market. Use of these facilities also increases the supply of reserves in the system. The enhanced clarity for firms that Fed facilities are a fully acceptable venue to get same-day liquidity for their HQLA should help reassure firms about holding reserves and their close substitutes, such as Treasury securities, in their liquidity portfolios."
He also says, "Specifically, we are exploring a requirement that larger banks maintain a minimum amount of readily available liquidity with a pool of reserves and pre-positioned collateral at the discount window, based on a fraction of their uninsured deposits. Community banks would not be covered, and we would take a tiered approach to the requirements. The collateral pre-positioned at the window could include both Treasury securities and the full range of assets eligible for pledging at the discount window. It is vital that uninsured depositors have confidence that their funds will be readily available for withdrawal, if needed, and this confidence would be enhanced by a requirement that larger banks have readily available liquidity to meet requests for withdrawal of these deposits. This requirement would be a complement to existing liquidity regulations such as those that require the internal liquidity stress tests (ILST) I described earlier as well as meeting the liquidity coverage ratio (LCR)."
Barr adds, "Finally, we are reviewing the treatment of a handful of types of deposits in the current liquidity framework. Observed behavior of different deposit types during times of stress suggests the need to recalibrate deposit outflow assumptions in our rules for certain types of depositors. We are also revisiting the scope of application of our current liquidity framework for large banks. These enhancements to our liquidity regulations will help bolster firms' ability to manage liquidity shocks, and they will also be well integrated with our monetary policy tools and framework."
In other news, the U.S. Treasury's Office of Financial Research published a blog titled, "OFR Monitor Shows U.S. Money Market Funds Remain a Popular Parking Option for Investor Cash," which states, "Short-term funding vehicles, like U.S. money market funds (MMFs), have been attractive investments because of high interest rates. Continued cash inflows pushed MMF assets to $6.6 trillion on July 31, 2024, according to the OFR U.S. Money Market Fund Monitor (MMFM) data. MMFs hold short-term investments that allow for quick portfolio rebalancing and, absent a market or liquidity event, benefit from returns on high-yield holdings in the near-term."
The post continues, "The OFR U.S. MMFM relies on data collected by the Securities and Exchange Commission (SEC) on Form N-MFP. SEC amendments to Form N-MFP that required more frequent data points and altered some fund categories became effective at the end of Q2 2024. OFR extended the MMFM's release to accommodate the new data requirements and submission changes. As a result, this quarter's MMFM overview includes the July data release."
A section titled, "Assets Continue to Grow but at a Slower Pace" says, "MMF assets increased $106 billion or 1.6% over the four months ending July 31. This was a slower pace compared to the same period a year earlier, when regional bank stress weighed on depositor confidence and investors moved cash into MMFs.... Retail funds continued to experience relatively steady flows totaling $74 billion for the period.... Institutional investor inflows, in contrast, were uneven. Seasonal factors, the direct purchase of short-term investments, and fund liquidations contributed to these fluctuations."
It states, "Most of the inflows into institutional funds involved investors rebalancing portfolios toward government funds and away from institutional prime funds. This was partly from some sponsors converting their institutional prime funds to government funds ahead of new SEC rules on MMFs set to take effect in October. The new rules require that institutional prime funds impose mandatory redemption fees in certain circumstances. Approximately one-third of the $626 billion in prime institutional assets at the start of the year have been converted through July. Internal funds that function as liquidity pools for a mutual fund complex account for much of the shift."
Under the header, "MMF Holdings of Repo Increased" they comment, "MMFs continued to increase their investment in repurchase agreements (repos) with banks and dealers, as their participation in the Federal Reserve's Overnight Reverse Repo Facility (ON RRP) overall decreased.... MMFs' lending to these institutions through centrally cleared sponsored repos rose to $646 billion or 29% of total private repos, up from 27% in March and 24% a year earlier. At the individual fund level, there is significant dispersion across these exposures: Some funds do very little in sponsored repo, while others have as much as 45% of their portfolio in sponsored repo. The increased utilization of sponsored repo reduces MMFs' exposure to any particular counterparty; however, it does concentrate their exposure to the central counterparty."
They write, "MMFs continued to accept a broad range of securities as repo collateral. As of July, U.S. Treasury and government agency securities collateralized about 69% and 28% of MMF repo transactions, respectively. MMFs' remaining repos were collateralized by corporate bonds, equities, and private label structured investments."
Finally, the OFR writes, "Most U.S. Treasury repo collateral securities have maturities exceeding either one year or five years. If not for repos, MMFs would not be able to directly hold much of this collateral because SEC rules require that MMF assets have a remaining maturity of 397 days or less. However, U.S. Treasury repos are generally overcollateralized, meaning they are backed by collateral with a value that is typically 102% of the cash the MMF lends. Thus, MMFs should be protected if a repo counterparty defaults, provided the collateral value is marked-to-market daily and adjusted accordingly."
