Why Is the Federal Reserve Abetting a Drain of Deposits from Banks?
Every day, the Federal Reserve borrows money from money market mutual funds, GSEs and certain other nonbanks at its overnight reverse repurchase agreement (ON RRP) facility. The facility is subsidizing money market funds as an attractive alternative for uninsured bank depositors. Why is the Fed continuing to operate it at its current $2.2 trillion size?
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Currently, the Fed pays ON RRP depositors 4.80 percent, higher than more than a quarter of private repo transactions. Given that attractive rate, as noted, 40 percent of money market mutual fund investments (44 percent for government funds) are overnight RRPs with the Fed, and the Fed is borrowing $2.2 trillion through the facility, nearly a quarter of all Fed liabilities including currency.
The ON RRP interest rate is attractive compared with other money market rates because it is currently only 10 basis points below the interest rate the Fed pays on reserve balances to banks (the IORB rate). For most of its history, the ON RRP rate was 25 below the IORB rate, and use of the facility was essentially zero. That higher spread lifts other money market rates up further above the ON RRP rate. To reverse the giant sucking of the ON RRP, all the Fed need do is lower the interest rate it pays.
In sum, the Fed’s fears for the ON RRP have been realized, and the ON RRP is causing significant damage at a time when it has lost its purpose. Shouldn’t that be a reason to change policy?
The full article is available at https://bpi.com/why-is-the-federal-reserve-abetting-a-drain-of-deposits-from-banks/