In advance of the November FOMC meeting, Federal Reserve Board staff conducted a Senior Financial Officer Survey. The SFOS is similar to the Quarterly Senior Loan Officer Survey but rarely used — the last survey was in 1998. We presume the survey was considered important to inform a discussion on the Fed’s monetary policy implementation framework at that meeting.
Thus, we were surprised to discover what seems to be a significant flaw in the survey.
Background
The FOMC is currently allowing its large portfolio of securities acquired in the crisis to run off gradually. A question important both for public policy and for financial markets is, “When will the runoff end?”
The Fed has financed its holdings with the deposits of banks, also known as “reserves.” As a result, when the securities decline, reserves also decline. Reserve balances that exceed the amount banks are required to hold are called “excess reserves,” and excess reserves are an important source of liquidity for banks. If the Fed wishes to keep conducting monetary policy essentially as it has since the crisis, it will need to stop the runoff when the market for excess reserves gets tight. Thus, a key determinant of how long the balance sheet runoff will continue is the minimum quantity of excess reserves banks desire to hold.
The Determinants of Excess Reserve Demand
A bank’s demand for excess reserves is determined by multiple factors. These indisputably include regulatory constraints. For all banks, this includes the need to meet the Liquidity Coverage Ratio and, for larger banks, includes resolution planning requirements and a now-publicly acknowledged examination mandate that a specified percentage of their high-quality-liquid assets be composed of excess reserves. These factors are hardly a secret – numerous analyst reports have been written describing how they affect reserve balances, and thus how they have contributed to some recent disruptions in short-term markets. Market participants with whom we’ve spoken are keenly focused on these factors.
The Survey
The question included in the Fed’s Senior Financial Officer Survey was as follows:
Please rate the importance to your bank of the following considerations in determining the approximate lowest dollar level of reserve balances that your bank would be comfortable holding before it began taking active steps to maintain or increase its reserve balance position on a scale of 1 (not important), 2 (somewhat important), 3 (important), or 4 (very important), or, if the factor is not applicable to your bank (for example, your bank is not subject to the regulatory requirement or does not engage in the described activity), please select “N/A.”
- Meeting routine intraday payment flows:
- Meeting potential deposit outflows:
- Satisfying internal liquid stress metrics:
- Satisfying the bank’s reserve requirements:
- Seeking to earn the IOER rate instead of the return on other high-quality liquid assets:
- Managing liquidity portfolio based on monetization assumptions for high-quality liquid assets.[1]
The survey included no potential response relating to liquidity regulations or other regulatory or examination mandates. (Interestingly, it seems clear that an earlier draft must have included such a response, as the definition of “N/A” includes “your bank is not subject to the regulatory requirement.” But the final survey contained no reference to any regulatory requirement other than reserve requirements, to which all banks are subject.)
Thus, as the FOMC decides on its monetary policy framework, it may have been informed that according to the Senior Financial Officer Survey, regulatory requirements have no effect on how that framework operates.
Disclaimer: The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Bank Policy Institute or its membership, and are not intended to be, and should not be construed as, legal advice of any kind.
[1] See pp. 7-9 https://www.federalreserve.gov/data/sfos/files/senior-financial-officer-survey-201809.pdf
