In the early stage of this crisis, the Fed’s concern was that banks didn’t have enough usable liquidity.
Photo: Caroline Brehman/Zuma PressFirst the worry was that American banks wouldn’t have enough cash. Now the problem seems to be that they have too much of it.
In the early phase of this crisis, the Federal Reserve’s concern was that banks didn’t have enough usable liquidity to absorb the market’s panic selling, causing huge volatility in vital markets like those for Treasurys and mortgage-backed securities. Now, after two weeks of Fed inducements via supervisory measures, liquidity injections and bond buying, the system appears to be awash with cash.
One consequence has been that repurchase agreement or repo rates are calm. Trends in repo indicate “cash supply is abundant,” analysts at KBW wrote.
But liquidity wasn’t the market’s only problem. Now that everyone can get their hands on cash, the inclination appears to be to stick it in a bank for safekeeping. Corporations putting newly borrowed cash into their coffers, plus Fed bond buying, plus investors’ successful liquidation of risky assets, has led to a flood of cash into banks in search of safety.
U.S. commercial bank deposits grew by more than $420 billion from the end of February to March 18—an extraordinary amount that puts March on track for a year’s worth of deposit growth, according to Brian Foran of Autonomous Research.
In that context comes the Fed’s latest move to let the biggest banks temporarily exclude Treasurys and cash on deposit at the Fed from their assets in certain calculations of how leveraged they are. Banks can only lend out so much under their capital rules, so a lot of these deposits end up ultimately parked at the Fed or in Treasurys.
The Fed said this temporary rule change should reduce capital requirements by about 2%. It also urged banks not to use this freed-up capacity to increase capital distribution to shareholders, but to “mitigate the effects of [capital] restrictions and better enable [banks] to support the economy.”
Now that possible credit providers of all stripes—including not just banks but also investors and companies—have cash or access to it cheaply, the challenge is getting them to use it on the parts of the economy that need it most. This won’t be easy, with credit risk now coming to the forefront. Even for banks, who still face other capital requirements, freed up leverage doesn’t mean they will have unlimited risk appetite to lend, nor should it.
Liquidity is an important part of enabling credit to flow. But it can only go so far in helping people who have lost their jobs or businesses that have no customers.
Write to Telis Demos at telis.demos@wsj.com
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Now Banks’ Problem Is Too Much Cash - The Wall Street Journal
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