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Too Much Cash in the System: Bank Deposits Exceed Bank Lending

Too Much Cash
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EDITOR NOTE: The Fed launched its reverse repo program RRP in 2013 to mop up extra cash in the repo market and to establish a floor under its fed funds rate (currently 0% to 0.25%). Financial institutions can lend cash to the Fed in return for Treasury collateral on an overnight basis. But right now, the market is swimming with too much cash in the banking system, mainly due to the Fed’s asset purchases (QE) prompted in response to the pandemic. As the debt ceiling suspension expires at the end of July, the US Treasury will need to reduce its cash balance in its Treasury General Account, from around $711 billion to $450 billion. This, in turn, increases reserves in the banking system, much of which flows into the RRP market. In short, there’s too much money in the system and we’re looking at $2 trillion more flowing into the facility by the end of summer.

Typically, banks make money by taking deposits at low rates and lending to borrowers at higher rates (car loans, residential mortgages, business loans, etc.), earning a spread. And bank deposits are usually less than the loans that they extended. Until April 2020. Nothing has been the same since Covid.

Too Much Cash

This is really a unique time, since during the last recessions (2001 and The Great Recession) bank credit exceeded bank deposits.

Too Much Cash

Banks can turn to The Federal Reserve at times like these. The Fed’s reverse repo program lets eligible firms, like banks and money-market mutual-funds, park large amounts of cash overnight at the Fed, at a time when short-term funding rates have fallen to next to nothing, and finding a home for cash has become harder.

But we are seeing a temporary decline in overnight reverse repo agreements.

Too Much Cash

In other words, there is too much cash in the system. And Credit Suisse’s Zoltan Pozsar calculates that we’re looking at $2 TRILLION of flow into Reverse Repos by the end of August.

We shall see if The Federal Reserve ever leaves markets with the effective Fed Funds rate at 8 basis points and The Fed’s balance sheet at over $8 TRILLION. Now, THAT’S a lot of cash in the system.

Original post from Confounded Interest

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