Prime institution money market funds sponsored by bank holding companies (BHCs) are essentially different from similar funds not offered by banks because the banking firms can extend “shadow insurance” to their ailing funds, according to a new paper released Tuesday.
The paper, developed and released by the Federal Deposit Insurance Corp. (FDIC), noted that after September 2008, when industry risk increased as the financial crisis exploded, expense ratios for BHC-sponsored prime institution money market funds (PI-MMFs) were seven basis points higher than those of non-BHC-sponsored MMFs.
“This increase is of similar size to the average deposit insurance premium charged by the FDIC in 2008,” the paper states. “We also show, despite higher expense ratios, the redemptions in BHC-sponsored MMFs were lower in contrast to expectations of prior literature.”
According to the findings of the paper, BHC-sponsored PI-MMFs operated as if they were under a government safety net during the sample period of the study (September 2008). The paper asserts that the BHCs were not “shadow banks,” in the sense that they lacked access to the government safety net.
“Instead, banks were operating in the shadows and extending a shadow insurance to institutional investors through affiliated money market funds,” the paper states. “In return, the affiliated money market funds charged higher expense ratios.”
The paper notes that, however, the BHCs had no reserve or capital requirements and paid no fees to the federal insurer against the risks they assumed because of their sponsorship of the fund. “Thus, the bank-sponsors benefited from potential government support without bearing any additional costs, leading to regulatory arbitrage,” the paper notes.
Shadow Insurance? Money Market Fund Investors and Bank Sponsorship