The U.S. Federal Reserve is currently competing with commercial banks due to a facility known as the “overnight reverse repurchase agreement facility,” which has attracted over $2 trillion in deposits. According to experts, this has affected bank deposits, as investors are attracted to the higher yields compared to traditional banks.

The Federal Reserve ‘Reverse Repo’ Facility Is Influencing Banks’ Deposits, Analysts Say

The recent banking turmoil has caused people to worry about the security of the U.S. banking system, and while at the higher levels some are still attempting to determine the causes that led to the collapse of Silvergate, Signature, and Silicon Valley Bank, there is another development that is impacting the health of this system.

The “overnight reverse repurchase agreement facility,” or reverse repo, as it is widely referred to, allows money market funds, which are investment vehicles known to invest in low-risk instruments, to park their money with the U.S. Federal Reserve while earning higher interest than what commercial banks offer.

The facility, which was established in 2013 by the Federal Reserve as a backstop for a potential shortage of low-risk investment options in the market, ended last month with $2.3 trillion in funds, down from a record of $2.5 trillion reached on December 30, 2022, based on numbers from the St. Louis Fed.

Analysts have stated that the availability of this instrument is causing flight-to-quality flows away from bank deposits, which have decreased by nearly $126 million in the weeks following the banking crisis, representing the largest drop since June 2021. The Bank Policy Institute (BPI), a research membership group for U.S. banks, commented:

While money funds also invest in Treasury bills, when they pile into bills, bill yields call, diminishing their attractiveness. It is only the reverse repo with its yields that is insensitive to supply and demand, that functions as a black hole for bank deposits.

Proposed Solutions to the Problem

This “black hole,” as the BPI labeled it, has a relatively simple solution, according to some. As per an article from Axios, this is an issue of returns, as the banks are not competing with the Federal Reserve, offering fewer yields, and ones not as attractive to investors. Neil Irwin, chief economic correspondent at Axios stated:

The sucking sound of money leaving banks would not be so loud if they paid more competitive returns.

The purpose of the reverse repo facility has already been criticized during quantitative tightening, with the BPI stating that it has “lost its purpose.” For the banking group, the answer involves a change in the inner workings of the mechanism, with the federal reserve decreasing the returns it offers. It said:

To reverse the giant sucking of the reverse repo, all the Fed need do is lower the interest rate it pays.

What are your thoughts on the reverse repo facility and its effect on bank deposits? Let us know in the comment section below.

Sergio Goschenko

Sergio is a cryptocurrency journalist based in Venezuela. He considers himself late to the game, entering the cryptosphere when the price surge occurred during December 2017. With a computer engineering background, living in Venezuela, and being impacted by the cryptocurrency boom at a social level, he provides an alternate point of view about crypto success and how it aids the unbanked and underserved.

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