Friday, July 14, 2017

Zero Hedge — 40% Of The Fed's Interest On Excess Reserves Is Paid To Foreign Banks


Interesting factoid.
While we will reserve judgment, and merely point out that of the $100 or so billion in dividends and buybacks announced by US banks after the latest stress test a substantial amount comes directly courtesy of the Fed - cash that ultimately ends up in shareholders' pockets - we will note that the interest the Fed pays to foreign banks operating in the US who have parked reserves at the Fed, amounts to $10.4 billion annualized as of this moment.

This is a subsidy from the Fed, supposedly an institution that exists for the benefit of the US population, going directly and without any frictions to foreign banks, who - just like in the US - then proceed to dividend and buybacks these funds, "returning" them to their own shareholders, most of whom are foreign individuals.

While the number appears modest, it is poised to grow substantially as the Fed Funds rate is expected to keep growing, ultimately hitting 3.0% according to the Fed.
Indicatively, assuming excess reserves remain unchanged for the next 2-3 years and rates rise to 3.0%, that would imply a total annual subsidy to commercial banks amounting to $65 billion, of which $25 billion would go to foreign banks every year.

We wonder if this is the main reason why the Fed is so desperate to trim its balance sheet as it hikes rates, as sooner or later, someone in Congress will figure this out.
 Zero Hedge
Tyler Durden

23 comments:

Matt Franko said...

Ok Where did the banks get the reserves to "park at the Fed" ?

Tom, why keep posting this garbage without accompanying ridicule?

Tom Hickey said...

It's obvious that reserve balances from transactions in USD. Where else could they come from These are multinational or transnational banks.

Some at least happen to be holding excess rb, most likely as a result of QE.

What's the problem?

Neil Wilson said...

Interesting that Zero Hedge haven't worked out the obvious point yet - the US dollar currency zone extends well beyond the country's borders.

What were they expecting with free capital movement?

Yet again a bunch of people translating the real national borders of real things onto the virtual world of finance that operates with interacting currency zones. The borders of one have little relationship to the other.

Matt Franko said...

Well where else can they "park them"?

They are implying member institutions have a choice.... they don't....

They think they are "parking" them instead of "lending them out"..

These are zero risk low returning assets that the banks in reality are lobbying Treasury to not even have to be regulated against.... they are balances at the CB for crying out loud... that banks are forced to maintain regulatory capital against just as any other risk asset... no wonder they are just buying back shares and increasing dividends in this environment it's the smart move...

Ralph Musgrave said...

There's an easy way for the Fed to reduce what it pays out in interest without the result being a general decline in interest rates: just raise private banks' minimum reserve requirements. The Chinese regularly adjust private banks' reserve requirement. Can't see why Western central banks don't do the same: in fact no one even seems to discuss this possibility.

Tom Hickey said...

The way I read the post is that it is about a subsidy to foreign banks owing to the way the system is structured.

The interesting point is that if Congress realizes this, ZN opines they will not like it. The question is what they can do about it without rejiggering the whole system.

The other question it raises is why central banks should be subsidizing even domestic banks with IOER, especially when they are highly profitable enterprises.

Once the payments system is understood along how it operates in terms of interest rate setting wrt to price and quantity then the issue of subsidies naturally arises.

It's a tradeoff involved in the way that monetary operations and policy execution are currently structured.

It would be interesting to see how the US Congress would deal with it.

Tom Hickey said...

There's an easy way for the Fed to reduce what it pays out in interest without the result being a general decline in interest rates: just raise private banks' minimum reserve requirements. The Chinese regularly adjust private banks' reserve requirement. Can't see why Western central banks don't do the same: in fact no one even seems to discuss this possibility.

That's because raising RR reduces banks' profitability.

Andrew Anderson said...

Actually, since reserves have the shortest maturity (zero wait) of all risk-free* sovereign debt and since no risk-free sovereign debt should yield more than 0% to avoid welfare proportional to account balance, then reserves** should be subject to NEGATIVE interest.


*Not all sovereign debt is risk-free since physical fiat, a.k.a. "cash", can be lost or stolen.

** An individual citizen exemption of up to, say, $250,000 should exist since SOME risk-free capital formation and liquidity is justifiable.

Jose Guilherme said...

why central banks should be subsidizing even domestic banks with IOER

In the current environment of trillions of dollars, euros, etc. in reserves as a result of massive QE the central banks have no choice: they have to pay IOR, otherwise the interbank rate would fall to zero.

Jose Guilherme said...

Perhaps ZH should check this (very good) one out:

https://www.newyorkfed.org/medialibrary/media/research/epr/08v14n2/0809keis.pdf

Tom Hickey said...

Right. It is a matter of institutional arrangements.

But it is still a bank subsidy, since it is a policy choice rather than a necessity.

Some would say it is not only a subsidy but also a windfall profit from emergency policy instituted because of the crisis and therefore it should be taxed away.

More would probably be OK with taxing foreign banks more than domestic ones.

This another instance where the positive and normative collide.

Matt Franko said...

Tom, you are being taken in by all of these morons....

Tom Hickey said...

The MMT economists call it a subsidy, too. It's a subsidy and it is going to "foreign" banks. They don't think Congress would be OK with this. The implication is that Congress is OK with subsidies going to US banks and that was a basic idea behind QE — staving off insolvency and recapitalizing the banks.

Jose Guilherme said...

It's a subsidy and it is going to "foreign" banks

Is it really going to foreign banks? Nowhere does ZH back this claim - certainly this cannot be inferred from the Fed's H.8 and H.4.1 statistical release that the ZH chart cites as a source for their claim that 40% of IOER goes to foreign banks.

The Fed's site simply states that "U.S. law allows foreign central banks and several international organizations to maintain dollar-denominated deposit accounts at the Federal Reserve" - this provision thus concerns foreign central banks, not foreign commercial banks.

On the Fed's site one can also read that "More than 5,500 depository institutions maintain accounts at the Federal Reserve Banks". These are presumably U.S., not foreign depository institutions.

See here: https://www.federalreserve.gov/monetarypolicy/bst_frliabilities.htm

Tom Hickey said...

Who Is Holding All the Excess Reserves? - FRBCleveland

Foreign Banks and the Federal Reserve

Non-U.S. Banks Operating in the United States—The Federal Reserve as Gatekeeperf

Foreign Banking Organizations - BOG of the FRS

Neil Wilson said...

"But it is still a bank subsidy, since it is a policy choice rather than a necessity."

It it? Because there is a dollar deposit liability created at the same time that in aggregate the banks can't get rid of.

Bank reserves are a forced loan to the central bank at a pre-determined interest rate, and loans create deposits.

So the question is what are they paying on the extra deposits?

And what currency are they in?

Andrew Anderson said...

... otherwise the interbank rate would fall to zero. Jose Guilherme

That's a consequence of the fact that the use of fiat in the convenient, inherently safe form of account balances at the central bank is limited, in the private sector, to approximately 6000 depository institutions, a.k.a. "banks." Hence the demand for fiat is artificially low; fiat having been replaced for general use in the economy by private bank deposits.

Hence the ethically proper way to increase demand, and thus interest rates. in fiat is to allow ALL citizens, their businesses, etc. to have inherently-safe accounts at the central bank and to abolish government-provided deposit insurance and other privileges for depository institutions.

Not that high interest rates in fiat are good either but an ethically proper way to lower them would be, for example, equal fiat distributions to all citizens.

Tom Hickey said...

It's a subsidy since "the natural rate is zero."

Andrew Anderson said...

"the natural rate is zero." Tom Hickey

What a sick joke; the general population is not even allowed to use fiat except in the form of unsafe, unhygienic, inconvenient physical fiat, a.k.a. "cash" and yet somehow the "natural" interest rate in it is zero!

What is natural about citizens not being allowed to use their Nation's fiat except for the aforementioned, pitiful and perhaps soon to be abolished exception of physical fiat?

What is natural about government privileges for banks?

Tom Hickey said...

Let's review what I take to be the point of ZH post.

The GFC sparked a banking crisis that the Fed addressed by requesting emergency powers from Congress to save the system (by saving the banks). The result was a number of special facilities and operations, including QE. QE (POMO) greatly expanded the Fed's balance sheet and increased banks rb, thereby increasing excess reserves way beyond normal operations (OMO).

In other worlds with OMO, there would not have been the amount of excess rb and the resultant need for IOER for the Fed to retain control of the policy rate instead of letting it fall to zero.

To retain control of the policy rate which would otherwise have fallen to zero, the Fed instituted paying IOER, supposedly as a temporary emergency measure.

The hidden agenda was to recapitalize the banks, which many believed to be either insolvent or close to it. There was no economic reason to prevent the policy rate from going to zero. Many monetary economists were calling for negative policy rates.

Paying IOER above zero was a policy choice.

This was a gift of government to privately own institutions.

The links I posed above show that a good many banks operating in the US, requiring with access to the payments system, were foreign-owned.

ZH wondered how Congress would feel about this if they realized it. Hint, hint, someone clue them in.

I am wondering how the public would feel about not only foreign but also domestic banks receiving subsidies when ordinary people were left twisting in the wind.

Jose Guilherme said...

The Fed is raising interest rates because it believes the economy and inflation are picking up and higher interest rates will dampen demand.

There's no specific intention to "subsidize" banks that hold trillions in reserves - the subsídy is just an inevitable byproduct of a banking environment awash in reserves, where the only way to keep the interbank rate above zero is by paying IOR.

The Fed is also announcing its intention to shrink its own balance sheet. Let's see if they manage to do it without triggering another financial crisis. Bank CEOs like Jamie Dimon have already warned the Fed against this. However, until and unless the Fed contracts its balance sheet higher interest rates will mean more interest being paid to banks.

Also, the ZH claim that 40% of the IOER "subsidy" goes to foreign banks is wildly off the mark. That would imply that 40% of the equity of all the banks operating in the U.S. is held by foreign investors - and it just ain't so.

Tom Hickey said...

There's no specific intention to "subsidize" banks that hold trillions in reserves - the subsídy is just an inevitable byproduct of a banking environment awash in reserves, where the only way to keep the interbank rate above zero is by paying IOR.

What's the necessity for keeping the rate above zero?

Especially now that the yield curve is beginning to invert.

Jose Guilherme said...

The Fed - or at least a majority of board members - believes it has to increase rates because the economy is overheating.

They are likely wrong, but honestly wrong. It's their belief system, and such systems die hard.