Authors: Gara Afonso, Marco Cipriani, and Gabriele La Spada
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Staff Reports
Banks’ Balance-Sheet Costs, Monetary Policy, and the ON RRP
Number 1041
December 2022 Revised July 2024
December 2022 Revised July 2024
JEL classification: G10, G21, E41, E51, E58
Using a quasi-natural experiment, we show that quantitative easing (QE) interacts with bank regulation by increasing banks’ balance-sheet costs and, in turn, impacting both the size and portfolio choices of non-banks. During 2020-21, the Federal Reserve grew its balance sheet by $4.6 trillion, increasing bank reserves, deposits, and leverage. Concurrently, regulators provided Supplementary Leverage Ratio (SLR) relief to banks. Upon expiration of this relief in March 2021, banks had an incentive to shrink their balance sheets to reduce leverage. We show that around that time, money market funds (MMFs) affiliated with banks subject to the SLR experienced large inflows, as these banks shed deposits to save on balance-sheet space, pushing them into affiliated, off-balance-sheet funds. Moreover, MMFs with limited investment options shifted their portfolios toward the Overnight Reverse Repo (ONRRP) facility, a program through which MMFs invest with the Federal Reserve, as banks reduced their supply of wholesale debt. These two effects explain the dramatic increase in ONRRP take-up, which reached $2.4 trillion in 2022. The impact of banks’ balance-sheet costs on MMFs’ ONRRP investment is robust to controlling for the effects of interest-rate uncertainty and T-bill supply. Our results imply that when non-banks can access the central-bank balance sheet, they end up holding a share of central-bank liabilities, draining reserves and attenuating the impact of QE. When only banks have access, they must hold all the liquidity injected by the central bank, which limits their balance-sheet space; in this case, QE may increase non-bank intermediation, hindering financial stability.
Author Disclosure Statement(s)
Gara Afonso
The author declares that she has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
Marco Cipriani
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
Gabriele La Spada
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
The author declares that she has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
Marco Cipriani
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
Gabriele La Spada
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
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