The paper discusses a proposal to mitigate the vulnerability of MMFs to runs by introducing a “minimum balance at risk” (MBR) that that would provide a disincentive to withdraw funds from a troubled money fund. The MBR would be a small fraction of each shareholder’s recent balances that would be set aside in the event that they withdrew from the fund. Most regular transactions in the fund would continue as before, but redemptions of the MBR would be delayed for thirty days. The delay would ensure that redeeming investors remain partially invested in the fund long enough to share in any imminent portfolio losses or costs arising from their redemptions.
At present, investors in a troubled fund have a strong incentive to run because those that are first to the exit can get out with 100 cents on the dollar, leaving other investors in the same fund to bear any losses. The MBR proposal would substantially reduce the incentive to run and ensure more equitable distribution of any loss among investors in a fund. Under the proposal discussed in the paper, as long as an investor’s balance exceeds the MBR, the rule would have no effect on transactions and no portion of any redemption would be delayed if the remaining shares exceed the minimum balance.
Additionally, MBRs could strengthen market incentives for early market discipline for MMFs by clarifying that investors cannot quickly redeem all shares from a fund during a crisis. Investors would have strong incentives to identify potential problems well before any losses are realized. Furthermore, by discouraging investors from redeeming shares in a troubled MMF, the MBR would help the fund avoid the need for fire sales of assets to raise cash – an effect that not only benefits the fund and its investors, but also reduces contagion risk throughout the system.
"Further reform of money funds is essential for our nation’s financial stability. Proposals currently under consideration, that are consistent with the basic idea discussed in this staff report, would make the financial system much safer. I strongly endorse their adoption," said William Dudley, president of the New York Fed. Mr. Dudley noted that small investors could be exempted from the requirement to maintain a minimum balance as they were less prone to withdraw their money at the first sign of trouble.
The report, “The Minimum Balance at Risk: A Proposal to Mitigate the Systemic Risks Posed by Money Market Funds,” is coauthored by Patrick McCabe, Marco Cipriani, Michael Holscher, and Antoine Martin. Patrick McCabe is a senior economist in the Research and Statistics Division at the Board of Governors of the Federal Reserve; Marco Cipriani is a senior economist in the Research and Statistics Group at the New York Fed; Michael Holscher is an officer in the Markets Group at the New York Fed; and Antoine Martin is an assistant vice president in the Research and Statistics Group at the New York Fed.
The Minimum Balance at Risk: A Proposal to Mitigate the Systemic Risks Posed by Money Market Funds