Fed survey shows possible rate environment impacts on reserving; drivers of overnight funding activity

A recent survey of senior financial officers at banks showed that the respondents – which held about two-thirds of total reserve balances at the time – were keeping reserves well above their lowest comfortable level, though about half might decide to alter that in different interest rate environments, according to findings reported by the nation’s central bank.

The findings, released Thursday by the Federal Reserve Board, are from a survey conducted between Aug. 29 and Sept. 12 of senior financial officers at banks regarding their reserve balance management strategies and practices. Conducted by the Fed Board in collaboration with the Federal Reserve Bank of New York, the survey drew responses from 51 banks – 30 domestic banks and 21 U.S. branches and agencies of foreign banking organizations – representing a range of asset sizes and business models.

The reference period for most questions was August 2018. The report notes the following key takeaways:

  • Survey respondents indicated that their lowest comfortable level of reserve balances given the constellation of short-term interest rates prevailing at the time of the survey [meaning the rates on federal funds, Eurodollars, repurchase agreements, and short-dated U.S. Treasury bills] was notably smaller than the amount they held, on average, in August 2018. The aggregate lowest comfortable level of reserve balances of survey respondents was just over $600 billion, a little less than half the level of the respondent banks’ average reserve balance holdings [nearly $1.4 trillion, according to Fed data] in August 2018. [As noted earlier, respondent banks overall held roughly two-thirds of total reserve balances at the time of the survey.]
  • When asked to consider whether they would adjust their assessment of their lowest comfortable level of reserve balances in different interest rate environments where the opportunity cost of holding reserves increased substantially, the respondents were roughly split between those who reported this level would not change and those who indicated that they could economize on their lowest comfortable level of reserve balances.

Opportunity cost was defined as the difference between a constellation of short-term interest rates and the current level of the Fed’s interest on excess reserves (IOER) rate.

Four opportunity cost scenarios were offered, and the majority of respondents reported that their lowest comfortable level of reserve balances would remain unchanged if the opportunity cost of holding reserve balances was either 5 basis points lower or higher than prevailed in August 2018. As the opportunity cost of holding reserve balances increased, the report said, nearly half of the respondents reported that their lowest comfortable level of reserve balances would decrease by some amount, showing some willingness to economize on their lowest comfortable level of reserve balances as the opportunity cost of holding reserves rises.

The survey also asked banks about the ways they might rebuild reserve balances if balances fell below the lowest comfortable level; motivations for engaging in unsecured overnight wholesale funding markets; willingness to lend in such markets.

The Fed sometimes conducts this survey to obtain information about deposit pricing and behavior, bank liability management, the provision of financial services, and reserve management strategies and practices.

Federal Reserve Board releases results of survey of senior financial officers at banks regarding their reserve balance management strategies and practices

Senior Financial Officer Survey, September 2018