After reserve ballooned last spring in face of pandemic, banks now cutting back out of concern for net interest margins, report finds

Reserve balances at banks ballooned by $1.4 trillion as the coronavirus crisis became apparent last spring, but that growth has plateaued since then and is expected to begin to shrink out of a concern for net interest margins, according to survey results released Monday by the Federal Reserve.

In its survey of bank senior financial officers (conducted between Sept. 18 and Oct. 2, which includes responses from banks that held approximately three quarters of total banking system reserve balances at the time of the survey, for a total of 80 banks), the Federal Reserve reported that banks’ growth in reserve balances last spring – after the financial impact of the COVID-19 pandemic became apparent – was driven mostly by their need to “be prepared for potential drawdowns on committed credit lines or a desire to conduct asset/ liability matching, given a large inflow of deposits with potentially high runoff rates or both.”

Ultimately, the report states, banks added $1.4 trillion to their reserves over March and April.

Over the summer, the report states, banks “decelerated” their reserves creation, with only about one-third of bank officers responding to the survey saying their reserves had increased in August relative to that of the spring. “Most of these respondents cited that the most or second most important driver of reserve accumulation during this period was a lack of attractive alternative investment opportunities or a desire to conduct asset/ liability matching, given a large inflow of deposits with potentially high runoff rates or both,” the report states.

For the remainder of this year (that is, for the fourth quarter), almost half of survey respondents said they expect a decrease in reserves relative to what they held in August. The reasons: concern over net interest margins, and an increase in the expected return on alternative high-quality liquid assets (HQLA) level 1 investments relative to the interest on excess reserves (IOER) rate.

Other key responses in the survey, the Fed said, included:

  • Nearly one-third of survey respondents indicated they are more likely to consider the discount window as a source of liquidity than before the Federal Reserve’s actions during the pandemic. Those who said they weren’t more likely to turn to the discount window cited concerns about disclosures.
  • Among the banks surveyed with Paycheck Protection Program (PPP) loans, most have not participated in the Fed’s PPP Liquidity Facility (PPPLF), which provides term financing backed by PPP loans to small businesses. The report stated that the banks often pointed to the availability of alternative funding sources at a lower cost relative to the PPPLF (for example, funding with core deposits), along with concerns over required PPPLF borrower certifications, as important or very important factors behind their decisions.

Federal Reserve Board releases results of survey of senior financial officers at banks about their strategies and practices for managing reserve balances

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