Throughout the past year, it has become abundantly evident that American banks are seeing a dramatic decline in deposits. It has been calculated that there has been a drop of about half a trillion dollars, which is equivalent to a staggering 3%. This is having a significant impact on commercial banks as they are compelled to reimburse deposits made. The crux of the issue, though, is that no one appears to know where the scenario is originating from at this time.
Currently, the experts are of the opinion that it most likely relates to money market funds. These are the less risky and shorter-term possibilities for investing in the corporate and government sectors. By themselves, these investments are generating insignificant returns.
In this case, however, there is no substantial inflow of money into such funds. The alternative is to deposit the money that a bank has issued and designated for the money market fund into the fund’s bank account. Due purchases are performed, and the resulting funds are deposited into the account of whoever is selling the asset. The way forward should be for the money that enters money market funds to remain within the banking system, rather than seeking an exit. In this regard, the Federal Reserve implemented a reverse-repo facility, which was unfortunately not particularly effective.
In the case of a repo transaction, the bank is borrowing from both its competitors and the central bank. In exchange, deposits in the form of collateral are made. In this circumstance, the money market fund wants the bank holding custody to deposit reserves at the Fed in exchange for securities. The intention was to aid the Fed in establishing a more cost-effective environment. The premise was that a shadow bank should not request a lower interest rate than the Federal Reserve.
Nevertheless, utilization of the facility has recently increased as a result of quantitative easing (QE). This occurred throughout the epidemic. As a result of the regulatory reforms, the banks now have more money. Beginning in 2020 and continuing for the subsequent two years, commercial bank deposits will increase by $4.5 trillion. When the pandemic began, the Fed relaxed a regulatory element known as the Supplementary Leverage Ratio (SLR), allowing banks to manage the increased money for a period. Afterwards, the exception was revoked.
Now that banks had an oversupply of funds, they ceased withdrawing from money market funds. The Fed received the cash. The Fed’s reverse-repo facility soon received deposits totaling $1.7 trillion. With the failure of SVB, smaller banks in the United States have been leery about deposit losses. In the case that an individual lacks a banking license, they should proceed to the repo facility. The returns are higher, and the danger is reduced. The concern is for small and mid sized banks in the United States.