Board of Governors of the Federal Reserve System

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

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Runnable money-like liabilities—an aggregate measure of private short-term debt that can be rapidly withdrawn in periods of stress—currently stand at about 70 percent of GDP (figure 4-3).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

References