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How Have Banks Been Managing the Composition of High-Quality Liquid Assets?

30 Pages Posted: 7 Sep 2017  

Jane E. Ihrig

Federal Reserve Board - International Financial Transactions

Ashish Kumbhat

Board of Governors of the Federal Reserve System

Gretchen C. Weinbach

Federal Reserve Board

Cindy M. Vojtech

Board of Governors of the Federal Reserve System

Date Written: 2017-08-30

Abstract

Leading up to 2014, banks generally increased their holdings of excess reserves as they moved to become compliant with the liquidity coverage ratio (LCR) requirement. However, once the LCR requirement was met, some banks shifted the compositions of their high-quality liquid assets (HQLA), reducing shares of reserves and increasing shares of Treasury securities and certain mortgage-backed securities (MBS). This raises the question: For a given stock of HQLA, what is its optimal composition? We use standard optimal portfolio theory to benchmark the ideal composition of a given stock of HQLA and find that a range of "optimal" HQLA portfolios is plausible depending on banks' tolerance for risk. A bank that is highly risk averse (inclined) prefers a relatively large share of reserves (MBS). Of course, the LCR is not the only constraint on banks' operations. We discuss how other factors interact with the LCR, and then examine the data for individual BHCs to show that they are currently employing a range of approaches to managing the compositions of their HQLA. In addition, we find that the pattern of dispersion in the daily variance of banks' HQLA shares supports the view that such factors are important drivers of banks' management of HQLA. Finally, we discuss possible policy implications of our results regarding the Federal Reserve's longer-run implementation of monetary policy.

Keywords: CAPM, HQLA, LCR, Bank balance sheets, Liquid assets, Liquidity management, Reserve balances

JEL Classification: E51, E58, G21, G28

Suggested Citation

Ihrig, Jane E. and Kumbhat, Ashish and Weinbach, Gretchen C. and Vojtech, Cindy M., How Have Banks Been Managing the Composition of High-Quality Liquid Assets? (2017-08-30). FEDS Working Paper No. 2017-092. Available at SSRN: https://ssrn.com/abstract=3030643 or http://dx.doi.org/10.17016/FEDS.2017.092

Jane Ihrig (Contact Author)

Federal Reserve Board - International Financial Transactions ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-452-3372 (Phone)
202-736-5638 (Fax)

Ashish Kumbhat

Board of Governors of the Federal Reserve System

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Gretchen Weinbach

Federal Reserve Board ( email )

United States
202-452-2841 (Phone)

Cindy Vojtech

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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