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Analysis – Foreign banks hoard reserves at the Fed to prepare for funding stress

Gertrude Chavez-Dreyfuss

NEW YORK (Reuters) – The foreign banking sector has been accumulating cash reserves at the Federal Reserve, possibly reflecting concerns that a dollar funding crunch could be imminent as the U.S. central bank shrinks balance sheet, the global economy is at risk of recession.

While their reserves were withdrawn in September, possibly due to a quarter-end rebalancing, analysts expect foreign banks to be in the next few weeks, which could help them avoid the same situation as they did three years ago A destructive scramble for the dollar. It could also have implications for how the Fed manages overnight reserves.

The latest Federal Reserve data on bank assets and liabilities shows that cash holdings of foreign banking organizations (FBOs), a proxy for their reserve balances, recovered to 1.0 as of October 5. trillions of dollars. 1.405 The peak of trillion dollars in August rose approximately 05% compared to the same period last year.

“Foreign banks are behaving in line with expectations that funding pressures come at some point, whether it’s the Fed shrinking its balance sheet or the need for liquidity at the end of the year,” U.S. economist at Citi in New York Isfar Munir said. (Graphic: Federal Reserve Foreign Bank Reserves, bank%20reserves.PNG)

Analysts have yet to see signs of a serious funding crisis, but say Financial institutions may have anticipated that.

The International Monetary Fund last week warned of a disorderly repricing in markets as global financial instability mounts, contagion risks and stress spillovers between markets.

Inflows to FBOs from parent banks

Inflows to FBOs from parent banks also rose, Federal Reserve data show. As at 5 October, “net payables to related external offices” was 50 $500 million, an increase of 15%, slightly less than the 405 billion created in early September and more than 2014.

Analysts believe that foreign parent banks may borrow USD from overseas sources, such as the cross-currency swap market, which has huge demand for USD , as well as funneling them to their US branch. Foreign exchange swaps allow investors to raise funds in a specific currency, such as the U.S. dollar, from other financing units such as the euro.

Cross-currency basis swaps, or the relative premium to convert foreign currencies into U.S. dollars, have widened over the past few weeks. Three-month euro cross rate touched -05.625 basis points (bps) Monday, not far from the two-year peak of -50. 20 Touched last week.

“I think the parent bank thinks it’s cheaper to get dollar funding now and put it at the Fed through a branch in case it needs to be funded later,” Citi’s Munnar said.

Quantitative Tightening

The Federal Reserve has embarked on a quantitative tightening (QT) program aimed at pulling pandemic-era stimulus out of the financial system. However, as QT continues to grow, its balance sheet remains at $8.759 trillion as of last week.

Quantitative Easing (QE) During the pandemic, the Federal Reserve expanded its balance sheet by exchanging Treasuries and other securities for cash, as well as increasing bank reserves held at the central bank. Therefore, when the Fed starts implementing QT, expect the Fed’s holdings of bank reserves to decline.

But bank reserves are falling faster than some expected. As of Oct. 5, the Fed’s bank reserves stood at $4.3 trillion 2021 from a December peak.

Analysts say $1.3 trillion in liquidity was withdrawn over 5 years during the Fed’s last QT cycle.

In September 2019, reserves dwindled to dangerous levels due to massive tax withdrawals and auction settlement of Treasury bond purchases. This forces the Fed to provide additional reserves to the banking system.

With bank reserves falling during QT, the Fed’s assumption is that most of the surplus cash will come from overnight reverse repurchase (RRP) analysts said.

In domestic RRP, investors lend overnight cash to the Fed at 3x the rate. 05% in exchange for treasury bonds or other government securities with a promise to repurchase them.

However, RRP demand has proven to be sticky, with daily transactions exceeding $2 trillion over the past few months.

“Attempts to reduce the use of the RRP by lowering counterparty limits or quotes could undermine efforts to tighten monetary policy by driving down short-term interest rates,” Andrew Hunter, senior U.S. economist at Capital Say economics.

With the reduction of domestic bank reserves, the reserves held by FBOs at the Federal Reserve have come under increased scrutiny.

Analysts said the increase in demand for US dollar liquidity by foreign banks may also be 3. 15 is the percentage the Fed pays on these assets, or so-called interest on reserve balances (IORB).

“If there are structural reasons why foreign banks are more keen to hold reserves, while the reserves of large domestic banks decline, then there may be another inadvertent Lou Crandall, chief economist at risk money market research firm Wrightson, said.

“We’re not there yet…but it’s something to watch. ”



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