Banks take action to reduce, limit reserve balance growth, survey finds; net interest margins cited

Nearly half of banks surveyed said they had taken actions to reduce either the level or growth of their reserve balances in the last six months, according to a report of the results of a survey of bank senior financial officers released by the Federal Reserve Tuesday.

In addition, the Fed said about 25% of respondents reported that their bank had taken actions to reduce the level or growth of its entire balance sheet in the last six months and that, looking ahead, about 40% of respondents reported that they expect their bank to take actions to reduce the level or growth of its reserve balances in the next six months.

The report is based on results of a survey conducted in November of last year with senior financial officers from 79 banks “representing a wide range of asset sizes and business models” on reserve management experiences in recent months. The Fed said the responding banks, in aggregate, held about 75% of total reserve balances when the survey was conducted.

The survey looked at expectations for balance sheet management in the months ahead, wholesale funding market activity, and the potential for additional investment in high-quality liquid assets (HQLA), the Fed said. It also gathered views on the Fed’s recently established standing repurchase agreement (repo) facility (SRF).

On reducing the level or growth of reserve balances, the survey found that those who intend to do so were concerned about net interest margins and an increase in the expected return on alternative HQLA investments relative to the interest on reserve balances (IORB) rate. Those factors were most cited as important or very important in the decision to take such actions.

Among respondents who rated these factors highly, most reported that increased holdings of other assets, including other Level 1 HQLA, non-Level 1 HQLA, and non-HQLA assets, were an important or very important component of their bank’s reserve management strategy, the Fed said.

Among respondents who reported that a concern about net interest margins or a desire to preserve or decrease balance sheet size was an important or very important factor that prompted their bank’s actions, the Fed said the most commonly reported important or very important liability adjustment actions were allowing outstanding wholesale funding liabilities to mature without replacement and reducing deposit rates on non-operational deposits.

On SRF views, the Fed survey found that almost 40% of the respondents whose bank is not already a counterparty to the SRF reported that their bank has expressed or intends to express interest in becoming a counterparty. Among these respondents, the Fed said, the factors that were most commonly reported as important or very important in explaining the interest in the SRF were that the SRF complements the discount window as a backstop liquidity source, that the respondent’s bank holds a large amount of eligible securities so an additional liquidity source would be beneficial, and that the SRF would provide increased short-term monetization capacity for the bank’s HQLA portfolio.

Among the respondents whose bank is not interested in becoming a counterparty to the SRF, the Fed said, the factors most commonly reported as important or very important to that outlook were that the respondent’s bank does not need an additional source of liquidity and that the respondent’s bank is not set up to transact as a cash borrower on the tri-party platform; and the incremental cost of establishing and maintaining this capacity exceeds the benefit of being an SRF counterparty.

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