Research Exchange: August 2023

Selected Outside Research

Money and the Public Debt: Treasury Market Liquidity as a Legal Phenomenon

In recent years, Treasury market liquidity has been challenged on several occasions and, in 2020, a near collapse of the market prompted the Federal Reserve to undertake the most aggressive central bank intervention in history. This article offers a new perspective on what has gone wrong, arguing that “a high degree of convertibility between Treasuries and cash generally requires intermediaries that can augment the money supply, absorbing sales by expanding their balance sheets on both sides.” In 2008, investors lost confidence in the money-like liabilities (known as repos) of these intermediaries, impeding their role in facilitating market liquidity. The article further explains that changes to market structure have since “pushed substantial Treasury dealing further beyond the bank regulatory perimeter, leaving public finance increasingly dependent on high-frequency traders and hedge funds” with destabilizing effects. Implications for reform of Treasury market structure are also highlighted.” Money and the Public Debt: Treasury Market Liquidity as a Legal Phenomenon

Dealers’ Treasury Market Intermediation and the Supplementary Leverage Ratio

The six largest U.S. Treasury securities dealers are subsidiaries of large U.S. bank holding companies,  which are required to maintain a supplementary leverage ratio of at least 5 percent at the BHC level. The SLR is measured as the ratio of a banking organization’s Tier 1 capital to its total leverage exposure. For most of the period since the start of 2018 when the SLR was implemented, most of the big six U.S. BHCs have maintained SLRs well above required minimum, but SLRs have trended down in recent quarters, approaching the 5 percent threshold. This note examines the contribution of dealer Treasury market intermediation to the leverage exposure of U.S. Global Systemically Important Banks (GSIBs) under the SLR rule, using regulatory filings of the big six U.S. BHCs and data of their dealer subsidiaries. The analysis finds that this contribution is relatively modest, mitigating concerns about potential effects of the SLR rule on Treasury market intermediation, although “it is possible that dealers could limit their Treasury intermediation in response to SLR pressures emerging from an increase in BHCs’ overall balance sheet size.” The Fed – Dealers’ Treasury Market Intermediation and the Supplementary Leverage Ratio (

Dealer Capacity and U.S. Treasury Market Functionality

This paper estimates a set of illiquidity metrics for the dealer-to-customer and interdealer segments of the market for U.S. Treasury securities. The analysis demonstrates that yield volatility is always a key driver of illiquidity. In addition, the analysis finds  that “as dealer balance sheet utilization reaches moderately high levels, balance sheet utilization metrics begin to add significantly to explaining illiquidity.” The results support the idea that there are two important components of the cost to market participants of obtaining immediacy. The first is the “direct cost to dealers per unit of asset absorbed from counterparties, including funding costs through the effects of debt overhang, risk-bearing agency costs to dealer traders and other costs that apply whether dealer inventories are high or low.” The analysis suggests that this component of market illiquidity is roughly proportional to yield volatility and explains about 82% of the daily variation in illiquidity. The second cost component is the opportunity cost to dealers of using some of the remaining available space on their balance sheets. The analysis suggests that “when dealer inventories or trade flows are very high, the opportunity cost of giving up some of the remaining available space on dealer balance sheets can be economically significant.” Dealer Capacity and U.S. Treasury Market Functionality – Federal Reserve Bank of New York (

Lending by Servicing: Monetary Policy Transmission Through Shadow Banks

This paper develops a conceptual framework, supported by empirical evidence, that provides insights into the mechanics of monetary policy transmission through shadow banks in the mortgage market. The framework highlights how the mortgage servicing activity of nonbank mortgage originators functions as a natural hedge against interest rate shocks and dampens the effect of monetary policy on shadow-bank mortgage lending. In particular, when interest rates rise, expected servicing income increases because of reduced prepayment risk, increasing the value of mortgage servicing assets and enabling shadow banks to obtain more funding. Bank mortgage lenders gain less of a funding benefit because of the capital charge on mortgage servicing assets and because of their access to deposits. The main empirical finding is that, in response to a contractionary monetary policy shock, shadow banks with a higher ex ante share of mortgage servicing rights in total equity reduce their mortgage lending relatively less.

The Rise of Nonbanks in Servicing Household Debt

It is well known that over the past two decades, deposit-taking institutions have been largely displaced by nonbanks in the market for mortgage origination and servicing. This paper documents the role of mortgage servicing transfers spurred by changes in bank regulation in reshaping the mortgage industry. Using a near universe of consumer credit records, the paper demonstrates that “banks increase transfers of mortgage servicing rights (MSRs) to non-banks following the announcement of Basel III’s higher regulatory costs of holding MSR assets for banks.” In addition, the analysis finds that “banks selectively transferred below-median income, subprime and 60+ day delinquent MSRs to non-banks” and that these servicing transfers tied to regulatory pressure had adverse effects in the form of increased foreclosures and personal bankruptcies. The paper concludes that the displacement of mortgage servicing from banks to nonbanks “increased existing disparities in financial risks across households.”

Destabilization of Bank Deposits Across Destinations – Assessment and Policy Options

The paper proposes a framework for analyzing bank runs and their broader financial stability implications based on classifying deposit outflows according to destination. For example, deposits may flow to another bank perceived to be more stable; or to a nonbank financial institution which has access to central bank liabilities and holds its inflows in this form. The paper also examines factors that have increased the potential for these shifts of funds to occur, such as new technology that “has facilitated shifts of funds from one account to another quickly.” It concludes that central banks, “can avoid becoming excessive destinations for commercial bank deposit outflows through the access of non-banks to their balance sheet.” However, while “some of the factors that contribute to the increased volatility of deposits can and should be contained through policy measures, others, like the intensified competition between banks will inevitably stay, and bank balance sheet management and liquidity regulation need to accept the new normal.”

Empirical Assessment of SR/CA Small-Dollar Lending Letter Impact

In March 2020, in response to pandemic shut-downs, financial regulators issued a joint statement encouraging small-dollar lending to help households meet unexpected expenses or temporary income shortfalls. The statement emphasized that offering short-term, unsecured credit products to creditworthy borrowers would be considered favorably for Community Reinvestment Act purposes. A May 20 follow-up letter put forth lending principles for responsible small-dollar loans. This note presents an empirical assessment of the effectiveness of this regulatory effort. The analysis finds evidence of a modest increase in lending in the small-dollar space in response to the regulatory guidance. The “most plausibly causal estimate” indicates that small dollar lending “was on average at least 3% higher at banks by the end of 2021 than in the absence of the letters.” The Fed – Empirical Assessment of SR/CA Small-Dollar Lending Letter Impact (

The Tail that Wagged the Dog: What Explains the Persistent Employment Effect of the 10-Day PPP Funding Delay

This study revisits the effect of the 10-day funding delay in the 2020 Paycheck Protection Program on employment recovery during the COVID-19 pandemic that has been identified in earlier studies. The analysis finds that the effect of the delay on employment recovery was not widespread; it was concentrated within the top one percent of urban counties by population. Moreover, the strong correlation between longer delay and slower employment growth in these counties reflects factors not previously considered, including that “the high rate of human interactions in major urban centers render these areas exceptionally and persistently vulnerable to infectious diseases”. The study also finds that “receiving more PPP funding and more transfers from other pandemic-related assistance programs contributed significantly more to local economic recovery compared with receiving PPP funds earlier.”

The Rise in Credit Card Debt Delinquencies

Although credit card delinquency rates were low during the COVID-19 recession, they have been on the rise since the end of 2021. This article examines  the recent spike in credit card delinquency rates, and in particular compares it to the increase during the global financial crisis. The analysis finds that current delinquency rates for younger people are near where they averaged in the 2007-09 global financial crisis and are especially high for those residing in areas characterized by longer-term financial distress.  Delinquent debt as a share of total credit card debt is smaller than during the global financial crisis. The Rise in Credit Card Debt Delinquencies | St. Louis Fed (

Stress-Test Models: A Survey

This paper presents a survey and assessment of the expanding literature on macroprudential stress‑testing models. The review encompasses models of contagion between banks and of contagion within the wider financial system, as well as models that incorporate the two-way interaction between the financial sector and the real economy. The assessment concludes that the modelling frontier faces three main challenges. The first is to advance “our understanding of the potential for amplification in sectors of the non-bank financial system during periods of stress.” Another is to further develop multi-sectoral models of the non-bank financial system for analyzing demand and supply of liquidity under stress. The third is to develop stress‑testing models that “incorporate comprehensive two-way interactions between the financial system and the real economy.” Macroprudential stress‑test models: a survey | Bank of England

Bank Expectations and Prudential Outcomes

Using a unique and rich data set from the U.K. covering key bank-level variables, including profitability, capital and loan impairments, this paper examines relationships among banks’ forecasting performance, measures of management quality, and realized performance outcomes. The analysis finds that banks overall “tend to be optimistic, expecting higher returns, higher capital ratios and fewer impairments than are subsequently realized”, but forecasting performance varies significantly across banks.  The analysis additionally indicates that banks with better quality governance and management tend to have smaller forecast errors. The analysis also finds that larger forecast errors are associated with greater prudential risk and with significantly lower subsequent loan growth. Bank Expectations and Prudential Outcomes | Bank of England

Chart of the Month

The Fed, OCC and FDIC have recently proposed significant increases in required capital ratios for large banks, which they justify by claiming that current requirements are at the low-end of estimates of optimal capital ratios. However, this statement is incorrect. As of Q2 2023, the aggregate CET1 capital ratio, a key measure of bank stability, is at 12.8% for all U.S. bank holding companies, including the largest ones. This falls in the middle of the 6-19% range of estimates cited by banking agencies and is near the high end of the 6 to 14.5% range indicated in recent academic studies. The chart is from a forthcoming BPI post.

Featured BPI Research

Central Bank Contingency Funding in Resolution Plans

The failures of Silicon Valley and Signature Banks in March illustrated that some uninsured demand deposits may flee a bank much more rapidly than had been thought.  Consequently, it may be appropriate to adjust upward the outflow rate under stress assumptions for some types of deposits in the liquidity regulations applicable to bank holding companies (BHCs) and banks. In a previous note the author argued that the upward calibration should be combined with a greater recognition of the contingency funding available to commercial banks from the Federal Reserve acting in the capacity for which it was created.  Doing so would avoid forcing banks to hold even more Treasury securities and reserve balances, which already make up more than 20 percent of bank balance sheets.  Instead, banks could continue to lend to businesses and households, prepositioning those loans as collateral at the Fed’s discount window to secure the additional contingency funding that now seems necessary. In this note, the author considers the circumstances under which it would be appropriate to count on a greater role for the Fed lending to a bank that has been recapitalized at a well-capitalized level pursuant to a resolution plan. Central Bank Contingency Funding in Resolution Plans – Bank Policy Institute (

It Was the Least They Could Do. No, Literally, It Was the Least They Could Do.

This post examines the announcement made by the U.S. banking agencies on July 28, 2023. The announcement issued additional guidance on liquidity risks and contingency planning for depository institutions. The announcement noted that if the discount window was part of the DI’s contingency funding plan, the DI should be operationally ready to borrow. The author notes that this announcement simply repeats what was already included in guidance and examination manuals. The author suggests that the agencies should have taken modest but still important steps to encourage banks to be willing and ready to borrow from the discount window. It Was the Least They Could Do. No, Literally, It Was the Least They Could Do. – Bank Policy Institute (

The Middle Course: What Fed History Teaches Us About Liquidity Requirements

In Feb 2023, BPI called for a holistic review of liquidity requirements. The organization pointed out that official assessments of a bank’s liquidity had undergone a sea change following the financial crisis. Prior to the Global Financial Crisis, to be liquid, banks were encouraged to have reliable and well-diversified sources of funding, including being prepared to borrow from the discount window. After the crisis, attention shifted to requiring banks to hold large amounts of high-quality liquid assets, and the discount window was to be shunned. In this note, the author explains how this sea change from an emphasis on diversified and reliable contingency funding to the stockpiles of HQLA (which, as we now know, failed to prevent the illiquidity event at SVB) was in fact a reversal of the policy that resulted in the creation of the Federal Reserve in 1913. After looking at the history of liquidity requirements, the author concludes with some policy recommendations. The Middle Course: What Fed History Teaches Us About Liquidity Requirements – Bank Policy Institute (

Conferences & Symposiums

9/7/2023 – 9/8/2023
Seventh Annual Fintech Conference
Federal Reserve Bank of Philadelphia
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9/28/2023 – 9/29/2023
22nd Annual Bank Research Conference
Federal Deposit Insurance Corporation Center for Financial Research
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10/4/2023 – 10/5/2023
Community Banking Research Conference
Federal Reserve Bank of St. Louis
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10/6/2023 – 10/7/2023
Ninth Wharton Conference on Liquidity and Financial Fragility
Wharton School of the University of Pennsylvania, Philadelphia
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10/19/2023 – 10/20/2023
New Perspectives on Consumer Behavior in Credit and Payments
Federal Reserve Bank of Philadelphia
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10/19/2023 – 10/20/2023
Federal Reserve Stress Testing Research Conference
Federal Reserve Bank of Boston and Virtual
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10/19/2023 – 10/20/2023
Annual Financial Stability Conference: Interest Rate Variability and the Financial Sector
Federal Reserve Bank of Atlanta
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The 2023 U.S. Treasury Markets Conference
Federal Reserve Bank of New York
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11/16/2023 – 11/17/2023
2023 Financial Stability Conference
Federal Reserve Bank of Cleveland and Office of Financial Research
Cleveland, OH and Virtual
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11/16/2023 – 11/17/2023
2023 Asia Economic Policy Conference
Federal Reserve Bank of San Francisco
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11/30/2023 – 12/1/2023
2nd CEMLA/Dallas Fed Financial Stability Workshop
Federal Reserve Bank of Dallas
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3/4/2024 – 3/7/2024
2024 National Interagency Community Reinvestment Conference
Portland, Oregon
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4/18/2024 – 4/19/2024
Inaugural Fintech and Financial Institutions Research Conference
University of Delaware and Federal Reserve Bank of Philadelphia: Announcement and Call for Papers
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The views expressed do not necessarily reflect those of the Bank Policy Institute’s member banks, and are not intended to be, and should not be construed as, legal advice of any kind.