4. Funding risk
Vulnerabilities from liquidity and maturity mismatches remain low
The total amount of liabilities that are most vulnerable to runs increased at a pace similar to nominal GDP over the past year and reached $14 trillion (table 4). Money market funds (MMFs) remained less susceptible to runs relative to before the implementation of money market reforms, and life insurers' nontraditional liabilities stayed below pre-crisis levels. Banks continued to rely relatively little on short-term wholesale funding and hold large amounts of high-quality liquid assets, reflecting liquidity regulations introduced after the financial crisis and banks' greater understanding of their liquidity risks.
Table 4. Size of Selected Instruments and Institutions
|Item||Outstanding/total assets (billions of dollars)||Growth, 2018 (percent)||Average annual growth, 1997–2018 (percent)|
|Total runnable money-like liabilities *||14,157||4.7||3.7|
|Domestic money market funds **||3,037||6.7||3.6|
|Securities lending ***||656||-2.0||7.4|
|Bond mutual funds||3,822||.3||9.1|
Note: The data extend through 2018:Q4, except for securities lending, which extends through 2018:Q3. Total runnable money-like liabilities includes uninsured deposits, repurchase agreements, domestic money market funds, commercial paper, and securities lending as well as several other types of liabilities, which are not listed individually in the table. Securities lending includes only lending collateralized by cash.
* Average annual growth is from 2003:Q1 to 2018:Q4.
** Average annual growth is from 2001:Q1 to 2018:Q4.
*** One-year growth is from 2017:Q3 to 2018:Q3, and average annual growth is from 2000:Q1 to 2018:Q3.
Source: Securities and Exchange Commission, Private Funds Statistics; iMoneyNet, Inc., Offshore Money Fund Analyzer; Bloomberg Finance LP; Securities Industry and Financial Markets Association: U.S. Municipal VRDO Update; Risk Management Association, Securities Lending Report; DTCC Solutions LLC, an affiliate of the Depository Trust & Clearing Corporation: Commercial Paper data; Federal Reserve Board staff calculations based on Investment Company Institute data; Federal Reserve Board, Statistical Release H.6, "Money Stock and Debt Measures" (M3 monetary aggregate); Federal Financial Institutions Examination Council, Consolidated Reports of Condition and Income (Call Report); Federal Reserve Board, Statistical Release Z.1, "Financial Accounts of the United States"; Morningstar, Inc., Morningstar Direct; Moody's Analytics, Inc., CreditView, ABCP Program Index.
Banks continue to have high levels of liquid assets and stable funding...
Banks have strong liquidity positions. Liquid assets at large banks continue to far exceed pre-crisis levels and are well above regulatory requirements at most large banks (figure 4-1). The composition of liquid assets has shifted from reserves toward Treasury securities and agency MBS, leading to some increase in duration risk. Meanwhile, short-term wholesale funding, which includes short-term deposits, federal funds purchased, and securities sold under agreements to repurchase, remains close to historical lows as a share of banks' total liabilities (figure 4-2).
...and run risk in short-term funding markets remains substantially below levels seen before the crisis
Runnable money-like liabilities—an aggregate measure of private short-term debt that can be rapidly withdrawn in periods of stress—currently stand at about 70 percent of GDP (figure 4-3). This level is significantly lower than its peak at the start of the financial crisis.
Money market funds continue to be less susceptible to runs...
In 2016, the Securities and Exchange Commission implemented reforms to limit risks associated with prime institutional funds (figure 4-4).8 As the deadline for implementation approached, assets under management at prime MMFs fell sharply, and many investors in those funds shifted their holdings to government MMFs, which hold securities backed by either the U.S. government or government-sponsored enterprises. Although assets under management at prime MMFs have edged up since then, they remain much lower than pre-reform levels.
...but mutual funds' holdings of corporate debt have grown notably in recent years...
U.S. corporate bonds held by mutual funds have more than tripled over the past decade to $1.4 trillion (figure 4-5). Mutual funds are estimated to hold about one-sixth of outstanding corporate bonds, and bank loan funds purchase about one-fifth of newly originated leveraged loans. Total assets under management in high-yield corporate bond mutual funds, which hold primarily riskier corporate bonds, and bank loan funds have more than doubled over the past decade to over $350 billion; these funds' assets declined at the end of 2018 but recovered some early this year (figure 4-6).
Corporate bond and bank loan mutual funds allow daily redemptions, even though it is significantly more difficult to buy and sell loans and corporate bonds than other assets such as equities and Treasury securities. The mismatch between these mutual funds' promise of daily redemptions and the longer time required to sell bonds or loans may be heightened if liquidity in these markets diminishesin times of stress.9 Investors concerned by this mismatch may increase their redemptions in such times, potentially putting additional pressure on market functioning.
High-yield bond and bank loan mutual funds experienced large outflows in December, when markets faced heightened volatility. However, high-yield bond mutual fund assets have rebounded some this year, while bank loan mutual funds continue to experience moderate outflows (figure 4-7).
Bid-ask spreads, a commonly used measure of market liquidity, widened in secondary markets for syndicated loans and corporate bonds amid the market turmoil late last year (figures 4-8 and 4-9). During this period of reduced market liquidity, mutual funds were able to meet the higher levels of redemptions without severe dislocations to market functioning. That said, market functioning was likely supported by the strong economic fundamentals and healthy state of the financial system, and a future stress episode with larger redemptions amid weaker economic fundamentals could lead to greater strains.
...while life insurers' nontraditional liabilities have stayed below pre-crisis peaks
Life insurance companies' nontraditional liabilities—repurchase agreements, funding agreement–backed securities, and securities lending cash collateral, all of which suffered runs during the financial crisis, as well as Federal Home Loan Bank, or FHLB, advances—have increased over the past few years (figure 4-10). However, the amounts of these nontraditional liabilities declined since the previous FSR and remain below pre-crisis peaks.10
8. In July 2014, the Securities and Exchange Commission adopted amendments to the rules that govern money market mutual funds to address risks of investor runs. The new rules, which became effective in October2016, require institutional prime MMFs to value their portfolio securities using market-based factors and sell and redeem shares based on a floating net asset value. The new rule also provided nongovernment MMF boards with tools—liquidity fees and redemption gates—to prevent runs. Return to text
9. These effects of liquidity mismatch can be more pronounced for bank loan funds than for bond funds because bank loans have a longer settlement period than corporate bonds, which can further increase the time between the sale of a bank loan and the receipt of cash by the fund. Return to text
10. The data on securities lending and repurchase agreements, or repos, of life insurers are not available for the pre-crisis period. However, the firm American International Group, Inc., or AIG, alone had $88.4billion in securities lending outstanding at the peak in 2007:Q3. See American International Group, Form 10-Q Quarterly Report for the Quarterly Period Ended September30, 2007. Return to text