Credit and Liquidity Programs and the Balance Sheet
- Recent balance sheet trends
- Open market operations
- Central bank liquidity swaps
- Lending to depository institutions
Federal Reserve liabilities
The major items on the liability side of the Federal Reserve balance sheet are Federal Reserve notes (U.S. paper currency) and the deposits that thousands of depository institutions, the U.S. Treasury, and others hold in accounts at the Federal Reserve Banks. These items, as well as the Federal Reserve's other liabilities, can be seen in tables 1, 5, and 6 of the H.4.1 statistical release.
The expansion of Federal Reserve assets that has resulted from the aggressive response to the current financial crisis has been matched by an expansion of the Federal Reserve's liabilities, particularly the deposits of depository institutions.
Federal Reserve notes, net of Federal Reserve Bank holdings
Historically, Federal Reserve notes have been the largest liability on the Federal Reserve's balance sheet. A U.S. depository institution, when it needs more currency to meet its customers' needs, asks a Reserve Bank to send it more Federal Reserve notes. The Reserve Bank ships the currency to the institution and debits the institution's Federal Reserve account by the amount shipped. Thus, an increase in Federal Reserve notes outside of the Reserve Banks is matched, in the first instance, by a reduction in the quantity of reserve balances that banks and other depository institutions hold in their Federal Reserve accounts. Similarly, a depository institution that finds that it has more Federal Reserve notes on hand than it needs to meet its customers' needs generally returns the extra currency to a Reserve Bank; the Reserve Bank credits the institution's account so the liability side of the Federal Reserve's balance sheet shows a reduction in Federal Reserve notes outstanding and a matching increase in reserve balances held by depository institutions.
The quantity of Federal Reserve notes held by the public has grown over time. Absent any additional action by the Federal Reserve, the increase in Federal Reserve notes would reduce the quantity of reserve balances held by depository institutions and push the federal funds rate above the target set by the Federal Open Market Committee (FOMC). To prevent that outcome, the Federal Reserve engages in open market operations to offset the reduction in reserve balances.
Reverse Repurchase Agreements
The Federal Reserve conducts reverse repurchase agreements (reverse repos or RRPs) by selling Treasury securities and federal agency debt securities to counterparties who agree to sell the securities back to the Federal Reserve on a stated future date. In normal times, the Federal Reserve executes occasional reverse repos with primary dealers; these transactions temporarily reduce the supply of reserve balances and thus help bring the federal funds rate back up to the target set by the FOMC when it has fallen below that target. During the fall of 2008, as part of its response to the financial crisis, the Federal Reserve executed a sequence of overnight reverse repos with primary dealers. While these transactions offset a modest amount of the increase in reserve balances that resulted from the expansion of the Federal Reserve's liquidity facilities, their more important effect was to make more Treasury securities available to private agents to use as collateral in money market transactions and thereby improve the functioning of the money markets. Every business day the Federal Reserve also conducts overnight reverse repos with foreign central banks that hold dollars in their accounts at the Federal Reserve Bank of New York. These transactions are one of the services that central banks provide one another to facilitate their international operations. Table 1 of the H.4.1 statistical release shows the two types of reverse repos separately; tables 5 and 6 show only the total. In December 2009, the Federal Reserve Bank of New York conducted its first set of small-scale, real-value, triparty reverse repurchase agreements to ensure the operational readiness at the Federal Reserve, the major clearing banks, and the primary dealers. The tests had no material impact on the availability of reserves or on market rates. Previous reverse repos conducted by the Federal Reserve were not conducted on a triparty repo basis.
Since late 2009, the Federal Reserve Bank of New York (FRBNY) has taken steps to expand the types of counterparties for reverse repos to include entities other than primary dealers. The additional counterparties are not eligible to participate in transactions conducted by the FRBNY other than reverse repos. Information about reverse repo counterparties is available at www.newyorkfed.org/markets/rrp_counterparties.html.
Additional series of small-scale, real-value reverse repos have been conducted since 2009, some of which were open to the set of expanded counterparties. Additional details and the results of these operations are available on the FRBNY website at www.newyorkfed.org/markets/omo/dmm/temp.cfm.
Deposits of Depository Institutions
More than 6,000 depository institutions maintain accounts at the Federal Reserve Banks. They hold balances in those accounts to make and receive payments or to meet reserve requirements. The total amount of balances in their accounts is shown in the line "depository institutions" under "Deposits" in tables 5 and 6 of the H.4.1 statistical release.
Many depository institutions borrow or lend in bank funding markets, such as the federal funds market. Those transactions move funds from the lender's Federal Reserve account to the borrower's account but do not change the total amount of balances that the banking system holds at the Federal Reserve Banks. The Federal Reserve can change the total amount of balances available to the banking system through its lending programs or through open market operations. As discussed below, transactions with the Treasury can also affect the supply of deposits of depository institutions.
When the Federal Reserve lends, all else equal, the total amount of deposits of depository institutions increases. When a depository institution borrows directly from the Federal Reserve, the amount the institution borrows is credited to its Federal Reserve account. When the Federal Reserve lends to a borrower that does not have an account at a Reserve Bank, the Federal Reserve credits the funds to the account of the borrower's bank at the Federal Reserve. When a borrower of either type repays the Federal Reserve, the process is reversed, and total deposits in depository institutions' accounts at the Reserve Banks decline.
An increase in the Federal Reserve's holdings of securities also raises the level of deposits of depository institutions. When the Federal Reserve buys securities, either outright or via a repurchase agreement, the Federal Reserve credits the account of the clearing bank used by the primary dealer from whom the security is purchased. Conversely, the Federal Reserve's sales of securities decrease the level of deposits of depository institutions. These types of securities purchases and sales are discussed in the section on open market operations.
During the week ending August 8, 2007, before the current financial crisis emerged, the deposits of depository institutions averaged about $12 billion per day. At that point, the federal funds rate, on average, was at the target established by the FOMC. In response to the crisis, the Federal Reserve began to expand its lending. To offset the associated increase in reserve balances, the Federal Reserve sold a significant portion of its holdings of Treasury securities to drain balances from the banking system. The effect of these open market operations was to allow the Federal Reserve to hit, on average, its target for the federal funds rate.
As the financial turmoil continued, and the Federal Reserve expanded its liquidity programs, the Open Market Desk was unable to offset completely the increase in deposits of depository institutions because it lacked a sufficient volume of unencumbered Treasury securities. Subsequently, however, the FOMC adopted a near-zero target range for the federal funds rate, and so a very large volume of reserve balances is now consistent with the target range. Deposits of depository institutions have been significantly higher than historical norms since late in 2008. The increase primarily reflected the net effects of Federal Reserve policy actions to provide liquidity to banking institutions and support the functioning of credit markets.
Depository institutions earn interest on the end-of-day balances they hold at the Federal Reserve. The interest paid on required reserve balances reduces the incentive for depository institutions to use otherwise productive resources to avoid reserve requirements. The interest rate paid on excess balances gives the Federal Reserve an additional tool for the conduct of monetary policy. An explanation of the payment of interest on balances is provided elsewhere on this website.
Deposits of the U.S. Treasury
The Federal Reserve is the fiscal agent of the U.S. Treasury. Major outlays of the Treasury are paid from the Treasury's general account at the Federal Reserve.
The Treasury's receipts and expenditures affect not only the balance the Treasury holds at the Federal Reserve, they also affect the balances in the accounts that depository institutions maintain at the Reserve Banks. When the Treasury makes a payment from its general account, funds flow from that account into the account of a depository institution either for that institution or for one of the institution's customers. As a result, all else equal, a decline in the balances held in the Treasury's general account results in an increase in the deposits of depository institutions. Conversely, funds that flow into the Treasury's account drain balances from the deposits of depository institutions. These changes do not rely on the nature of the transaction. A tax payment to the Treasury's account reduces the deposits of depository institutions in the same way that the transfer of funds does when a private citizen purchases Treasury debt. Both actions result in funds flowing from a depository institution's account into the Treasury's account.
With the dramatic expansion of the Federal Reserve's liquidity facilities, in September 2008 the Treasury agreed to establish the Supplementary Financing Program (SFP) in order to assist the Federal Reserve in its implementation of monetary policy. Under the SFP, the Treasury issues short-term debt and places the proceeds in the Supplementary Financing Account at the Federal Reserve. When the Treasury increases the balance it holds in this account, the effect is to drain deposits from accounts of depository institutions at the Federal Reserve. In the event, the implementation of the SFP thus helped offset, somewhat, the rapid rise in balances that resulted from the creation and expansion of Federal Reserve liquidity facilities. Treasury balances maintained in the SFP have been zero since July 2011.
Foreign Official Deposits
U.S. law allows foreign central banks and several international organizations to maintain dollar-denominated deposit accounts at the Federal Reserve. These balances are reported in the line "Foreign official" deposits in the liability sections of tables 1, 5, and 6 of the H.4.1 statistical release. An increase in foreign official deposits held at the Federal Reserve generally reflects a net transfer of dollars from depository institutions to the accounts of the foreign central banks and thus a reduction in deposits of depository institutions. Foreign official deposits held at the Federal Reserve have increased since the end of 2008, but they remain small relative to the overall size of the Federal Reserve's balance sheet.
The deposit accounts that foreign central banks maintain at the Federal Reserve sometimes also serve as conduits for the reciprocal currency arrangements ("central bank liquidity swaps") that the Federal Reserve has established with a number of foreign central banks. These arrangements allow the foreign central banks to obtain U.S. dollars from the Federal Reserve. In practice, however, because the foreign central banks tend to disburse these funds to banks immediately after the swap lines are drawn, the liquidity swaps tend not to be reflected in official deposits. Instead, the foreign central banks lend these dollars to banks in their jurisdictions by transferring funds to the accounts of the banks that clear dollar transactions for the borrowers. As a result, the extension of liquidity through swap lines has resulted not in an increase in foreign official deposits but rather in an increase in reserve balances held by depository institutions. Additional information is available in the "central bank liquidity swaps" section of this website.
U.S. law allows a number of government-sponsored enterprises (GSEs) to maintain deposit accounts at the Federal Reserve. Like the U.S. Treasury, these GSEs use their accounts to receive and make payments, which include receipts from issuing debt and payments for redeeming maturing debt. An increase in the line "other deposits" typically reflects a transfer of funds from depository institutions to one or more of these GSEs; thus, an increase in "other deposits" ordinarily is matched by a reduction in deposits held by depository institutions.