Reserve balances, the federal funds market and arbitrage in the new regulatory framework

Abstract

We study developments in reserve balances and the federal funds market in the context of two banking regulatory changes: the widening of the Federal Deposit Insurance Corporation (FDIC) assessment base and the introduction of the Basel III leverage ratio. Using a novel data set that includes FDIC fees and balance sheet data for depository institutions, we find that, as most foreign banks were not subject to the FDIC fee, they absorbed increasing amounts of reserve balances. Furthermore, foreign banks experienced positive and improving conditions for arbitraging between borrowing reserve balances in the federal funds market and earning interest on excess reserves by holding those reserves at the Federal Reserve Banks, contributing to an increase in federal funds borrowing by foreign banks relative to domestic banks. However, the implementation of the Basel III leverage ratio was associated with temporary declines in foreign bank federal funds borrowing at reporting dates.

Window dressing of regulatory metrics: Evidence from repo markets

“…1 Such behaviour can have adverse effects on financial stability for two main reasons. First, financial market functioning may be adversely affected if banks reduce the provision of certain services towards the end of a reporting period (Du et al (2018), Brand et al (2019)), where heightened volatility can also imperil the proper functioning of monetary policy (Duffie and Krishnamurthy (2016), Banegas and Tase (2019)). Second, window dressing may imply that reported and disclosed regulatory metrics overstate the resilience of individual institutions and the banking system as a whole and may also distort the estimation of banks' overall systemic importance under the G-SIB framework (Behn et al (2019), Garcia et al (2021)), resulting in a possible underestimation of risk and a misallocation of capital requirements in the banking system.…”

Insurance Pricing, Distortions, and Moral Hazard: Quasi-Experimental Evidence from Deposit Insurance

“…This result is consistent with the present article's finding on shifting funding sources in response to pricing, though their identification strategy and analysis time period differ from those of the current article. Other related papers include Keating and Macchiavelli (2017), Basten and Mariathasan (2018), Heider, Saidi, and Schepens (2019), Banegas and Tase (2020), Duquerroy, Matray, and Saidi (2020), and Kandrac and Schlusche (2021). Besides differences in the precise research questions and effects estimated, the present article is unique in using the disparity in deposit insurance premiums between BIF and SAIF members as a quasi-experiment to study the effects of the premiums on bank behavior.…”