The U.S. Federal Reserve may be competing with commercial banks for a facility called the “overnight reverse repurchase agreement facility” that is currently drawing over $2 trillion in deposits There is a possibility that the FRB may be competing with commercial banks. Analysts say this is affecting bank deposits as investors rush in for higher yields compared to traditional banks.
Analysts say the Federal Reserve “reverse repo” facility is affecting bank deposits
The recent banking crisis has people worried about the safety of the U.S. banking system. At a high level, some have identified the causes that led to the failures of Silvergate Bank, Signature Bank, and Silicon Valley Bank, but there is another phenomenon that affects the health of this system.
Reverse repos, or “overnight reverse repos,” are a facility that allows money market funds, known for investing in low-risk instruments, to deposit funds with the Federal Reserve while earning higher interest than commercial banks
The facility was introduced by the Federal Reserve in 2013 as a backstop for a possible shortage of low-risk investment options in the market, down from the record $2.5 trillion reached on December 30, 2022, by the St. Louis Fed’sfigureand last month ended with $2.3 trillion in funds.
Analysts say the use of this financial instrument is causing a flight from bank deposits, which fell by nearly$126 millionin the weeks following the banking crisis, the largest decline since June 2021. The Bank Policy Institute (BPI), a research membership organization for U.S. banks, said,:
Money funds also invest in government bonds, but when they pile into government bonds, the yield on government bonds is called, halving their attractiveness. It is the reverse repo, with its yield insensitive to supply and demand, that acts as a black hole for bank deposits.
Proposals to solve the problem
It’s a “black hole,” as BPI calls it, but according to some, there is a relatively simple solution: according to the Axios article, it’s a return problem, and since banks are not competing with the Federal Reserve, their yields are low and unattractive to investors. Neil Irwin, chief economic correspondent for Axios, said,
If banks paid more competitive returns, the sucking sound of money leaving the banks would not be so loud.
The function of reverse repo has already been criticized during the quantitative tightening, which BPI said “has lost its purpose.” For the banking group, the solution is to change the internal structure of the mechanism, so that the Federal Reserve will d
