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Reserve Balances, the Federal Funds Market and Arbitrage in the New Regulatory Framework

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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.

Suggested Citation

  • Ayelen Banegas & Manjola Tase, 2016. "Reserve Balances, the Federal Funds Market and Arbitrage in the New Regulatory Framework," Finance and Economics Discussion Series 2016-079, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2016-79
    DOI: 10.17016/FEDS.2016.079
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    1. Bech, Morten L. & Klee, Elizabeth, 2011. "The mechanics of a graceful exit: Interest on reserves and segmentation in the federal funds market," Journal of Monetary Economics, Elsevier, vol. 58(5), pages 415-431.
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    1. The Fed's successful tightening
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2017-03-27 17:33:49

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    Cited by:

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    2. Correa, Ricardo & Sapriza, Horacio & Zlate, Andrei, 2021. "Wholesale funding runs, global banks' supply of liquidity insurance, and corporate investment," Journal of International Economics, Elsevier, vol. 133(C).

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    JEL classification:

    • E49 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Other
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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