Quarterly Report on Federal Reserve
Balance Sheet Developments

Monetary Policy Tools

The Federal Reserve currently uses several tools to implement monetary policy in support of its statutory mandate to foster maximum employment and stable prices.

The Federal Reserve conducts open market operations (OMOs) in domestic markets. OMOs can be permanent, including the outright purchase and sale of Treasury securities, government-sponsored enterprise (GSE) debt securities, and federal agency and GSE mortgage-backed securities (MBS); or temporary, including the purchase of these securities under agreements to resell, and the sale of these securities under agreements to repurchase. The authority to conduct OMOs is granted under Section 14 of the Federal Reserve Act, and the range of securities that the Federal Reserve is authorized to purchase and sell is relatively limited. OMOs are conducted by the Trading Desk at the Federal Reserve Bank of New York (FRBNY), which acts as agent for the Federal Open Market Committee (FOMC). The FRBNY's traditional counterparties for OMOs are the primary dealers with which the FRBNY trades U.S. government and select other securities.¹

OMOs have been used historically to adjust the supply of reserve balances so as to keep the federal funds rate around the target federal funds rate established by the FOMC. In recent years, the Federal Reserve has also developed other tools to strengthen its control of short-term interest rates, and to reduce the large quantity of reserves held by the banking system when needed.

The Federal Reserve provides short-term liquidity to domestic banks and other depository institutions through the discount window. In addition, because of the global nature of bank funding markets, the Federal Reserve has at times established liquidity arrangements with foreign central banks as part of coordinated international efforts.

Permanent Open Market Operations

Recent Developments

• Between February 27 and May 1, 2013, the System Open Market Account's (SOMA's) holdings of Treasury securities increased, as purchases continued under the FOMC's purchase plan for longer-term Treasury securities announced on December 12, 2012.
• The SOMA's holdings of agency debt declined between February 27 and May 1, 2013, due to principal payments. Holdings of agency MBS increased, as purchases continued under the FOMC's agency MBS purchase plan announced on September 13, 2012, and as principal payments from agency debt and agency MBS are reinvested in agency MBS under the FOMC's reinvestment policy announced on September 21, 2011.

Background

Permanent OMOs are outright purchases or sales of securities for the SOMA, the Federal Reserve's portfolio. Permanent OMOs traditionally have been used to accommodate the longer-term factors driving the expansion of the Federal Reserve's balance sheet, principally the trend growth of currency in circulation. More recently, the expansion of SOMA securities holdings has been driven by large-scale asset purchase programs (LSAPs), which are described in more detail below. The composition of the SOMA is presented in table 2. The Federal Reserve's outright holdings of securities are reported weekly in tables 1, 3, 8, and 9 of the H.4.1 statistical release.

On September 28, 2012, the Federal Reserve began the regular publication of transaction-level information on individual open market transactions. In accordance with the Dodd-Frank Act, this information will be made available on a quarterly basis and with an approximately two-year lag. The transaction-level detail supplements the extensive aggregate information the Federal Reserve has previously provided in weekly, monthly, and quarterly reports, and is available at www.newyorkfed.org/markets/OMO_transaction_data.html.

On February 20, 2013, the FRBNY announced the introduction of a pilot program for a few small broker-dealers to participate in FRBNY operations to conduct outright purchases or sales of U.S. Treasury securities along with primary dealers. These new counterparties will not be eligible to participate in other types of OMOs. The program will run for about one year--a period long enough for the FRBNY to evaluate the benefits and costs of a wider range of participants in its SOMA operations.

Large-Scale Asset Purchase Programs

From March 2009 through March 2010, the Federal Reserve purchased direct obligations of the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal Home Loan Banks; MBS guaranteed by Fannie Mae, Freddie Mac, and the Government National Mortgage Association (Ginnie Mae); and longer-term Treasury securities.² More information on these actions is available at www.federalreserve.gov/monetarypolicy/bst_openmarketops.htm.

On November 3, 2010, the FOMC decided to expand its holdings of securities and announced that in order to promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the FOMC intended to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The last purchase under this program occurred on June 30, 2011.

On August 10, 2010, the FOMC announced that it would reinvest principal payments from agency debt and agency MBS in longer-term Treasury securities in order to maintain domestic securities holdings in the SOMA portfolio at the level intended under the LSAPs. On September 21, 2011, the FOMC announced that it would begin reinvesting these principal payments in agency MBS.

On September 13, 2012, the FOMC announced that it would increase policy accommodation by purchasing additional agency MBS at a pace of $40 billion per month, continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and maintain its existing policy of reinvesting principal payments from its holdings of agency debt and agency MBS in agency MBS. More information is available at www.federalreserve.gov/newsevents/press/monetary/20120913a.htm.

On December 12, 2012, the FOMC announced that it would continue purchasing additional agency MBS at a pace of $40 billion per month. The FOMC also announced that it would begin purchasing longer-term Treasury securities following the completion of its program to extend the average maturity of its holdings of Treasury securities, initially at a pace of $45 billion per month. In addition, the FOMC decided to maintain its existing policy of reinvesting principal payments from its holdings of agency debt and agency MBS in agency MBS and, in January 2013, to resume rolling over maturing Treasury securities at auction. More information is available on the Federal Reserve Board's website at www.federalreserve.gov/newsevents/press/monetary/20121212a.htm.

Maturity Extension Program

On September 21, 2011, the FOMC announced that it would extend the average maturity of its holdings of securities--by purchasing $400 billion par of Treasury securities with remaining maturities of 6 years to 30 years and selling or redeeming an equal par amount of Treasury securities with remaining maturities of 3 years or less--by the end of June 2012. The maturity extension program was intended to put downward pressure on longer-term interest rates and to help make broader financial conditions more accommodative. Additional information is available at www.newyorkfed.org/markets/opolicy/operating_policy_110921.html and www.newyorkfed.org/markets/pomo_landing.html.

On June 20, 2012, the FOMC announced that it would continue through the end of the 2012 its program to extend the average maturity of its holdings of securities. The maturity extension program concluded as scheduled and resulted in the purchase, as well as the sale and redemption, of about $667 billion in Treasury securities since the inception of the program.

Temporary Open Market Operations and Other Reserve Management Tools

Recent Developments

• Beginning on April 2, 2013, the FRBNY conducted a series of small-value reverse repurchase (reverse repo) transactions using all eligible collateral types. The first operation was conducted with the new reverse repo counterparties announced on January 15, 2013; the remaining operations were conducted with all eligible reverse repo counterparties. These types of transactions are conducted as a matter of prudent planning by the Federal Reserve and are designed to have no material impact on the availability of reserves or on market rates. They do not represent a change in the stance of monetary policy and no inference should be drawn about the timing of any change in the stance of monetary policy in the future. The results of these operations are available on the FRBNY's website at www.newyorkfed.org/markets/omo/dmm/temp.cfm.
• On May 20, 2013, the Federal Reserve awarded $10.5 billion of 28-day term deposits through the Term Deposit Facility (TDF). This TDF operation was the first that was conducted using a fixed-rate full-allotment format. Each participating institution was allowed to submit one tender with a maximum value of $1.25 billion that was awarded in full at the predetermined rate of 0.26 percent. The Federal Reserve had previously announced that it would consider various formats for the TDF as part of the development of the facility. The ongoing small-value TDF offerings are a matter of prudent planning and have no implications for the near-term conduct of monetary policy. Additional information about term deposits and recent operations is available through the TDF Resource Center at www.frbservices.org/centralbank/term_deposit_facility.html.

Repos and Reverse Repos

Temporary OMOs are typically used to address reserve needs that are deemed to be transitory in nature. These operations are either repos or reverse repos. Under a repo, the FRBNY Trading Desk buys a security under an agreement to resell that security in the future. A repo is the economic equivalent of a collateralized loan; the difference between the purchase and sale prices reflects the interest on the loan.

Under a reverse repo, the Trading Desk sells a security under an agreement to repurchase that security in the future. A reverse repo is the economic equivalent of collateralized borrowing. Reverse repos are a tool that could be used to support a reduction in monetary accommodation at the appropriate time.³ Amounts outstanding under repos and reverse repos are reported weekly in tables 1, 2, 8, and 9 of the H.4.1 statistical release.

In addition, the Federal Reserve has long operated an overnight securities lending facility as a vehicle to address market pressures for specific Treasury securities. Since July 9, 2009, this facility has also lent housing-related GSE debt securities that are particularly sought after. Amounts outstanding under this facility are reported weekly in table 1A of the H.4.1 statistical release.

Expanded Counterparties for Reverse Repos

Since late 2009, the FRBNY has taken steps to expand the types of counterparties for reverse repos to include entities other than primary dealers. This initiative is intended to enhance the Federal Reserve's capacity to conduct large-scale reverse repo operations to drain reserves beyond what could likely be conducted through primary dealers. The additional counterparties are not eligible to participate in transactions conducted by the FRBNY other than reverse repos.

In 2010 and 2011, the FRBNY initiated three waves of counterparty expansions aimed at domestic money market funds. With each wave, the set of eligibility criteria was broadened to allow more and smaller money market funds to participate as counterparties. In addition, on July 27, 2011, the FRBNY announced that it had accepted two GSEs--Freddie Mac and Fannie Mae--as reverse repo counterparties. On December 1, 2011, and April 30, 2012, the FRBNY announced that several banks had been accepted as reverse repo counterparties. On August 16, 2012, the FRBNY released another round of criteria for the acceptance of banks, savings associations, GSEs, and domestic money market funds as counterparties; institutions accepted under these criteria were announced on January 15, 2013.

Acceptance as a counterparty does not constitute a public endorsement by the FRBNY of any listed counterparty and should not substitute for prudent counterparty risk management and due diligence. Further information on reverse repo counterparties is available on the FRBNY's website at www.newyorkfed.org/markets/rrp_announcements.html and www.newyorkfed.org/markets/expanded_counterparties.html.

Small-Value Repo and Reverse Repo Transactions

The FRBNY periodically conducts small-scale, real-value triparty repo and reverse repo transactions to ensure operational readiness at the Federal Reserve, the major clearing banks, the primary dealers, and other counterparties. The transactions have no material impact on the availability of reserves or on market rates, and are a matter of prudent advance planning by the Federal Reserve. They do not represent any change in the stance of monetary policy, and no inference should be drawn about the timing of any change in the stance of monetary policy in the future.

In December 2009, the FRBNY conducted its first set of small-scale, real-value, triparty reverse repos with primary dealers. Additional series of reverse repos have been conducted since 2009, some of which were open to the sets of expanded counterparties (money market mutual funds, GSEs, banks, and savings associations).

In August 2012, the FRBNY conducted a series of small-value repo transactions with primary dealers using all eligible collateral types. The FRBNY had not conducted a repo since December 2008, and since that time six primary dealers had been added and there had been several changes to the infrastructure of the repo market.

Additional details and the results of these operations are available on the FRBNY website at www.newyorkfed.org/markets/omo/dmm/temp.cfm.

Term Deposit Facility

The TDF is a program through which the Federal Reserve Banks offer interest-bearing term deposits to eligible institutions. A term deposit is a deposit with a specific maturity date. The TDF was established to facilitate the conduct of monetary policy by providing a tool that may be used to manage the aggregate quantity of reserve balances held by depository institutions, and in particular (as with reverse repos) to support a reduction in monetary accommodation at the appropriate time. An increase in term deposits outstanding drains reserve balances because funds to pay for them are removed from the accounts of participating institutions for the life of the term deposit.

Term deposits may be awarded either through (1) a competitive single-price auction with a noncompetitive bidding option (which allows institutions to place small deposits at the rate determined in the competitive portion of the operation) or (2) a fixed-rate format with full allotment at an interest rate specified in advance.

Beginning in June 2010, the Federal Reserve has periodically conducted small-value TDF offerings as a matter of prudent planning. These offerings have no implications for the near-term conduct of monetary policy. Additional information about term deposits, auction results, and future small-value offerings is available through the TDF Resource Center at www.frbservices.org/centralbank/term_deposit_facility.html.

Discount Window Lending

Recent Developments

• Credit provided to depository institutions through the discount window remains generally around the levels seen prior to 2007. As presented in table 5, discount window credit outstanding on May 1, 2013, was less than $50 million, and the lendable value of collateral pledged by borrowing institutions on that date was $0.4 billion.

Background

The discount window helps to relieve liquidity strains for individual depository institutions and for the banking system as a whole by providing a source of funding in times of need. Much of the statutory framework that governs lending to depository institutions is contained in Section 10B of the Federal Reserve Act, as amended. The general policies that govern discount window lending are set forth in the Federal Reserve Board's Regulation A.

Depository institutions have, since 2003, had access to three types of discount window credit: primary credit, secondary credit, and seasonal credit. Primary credit is available to depository institutions in generally sound financial condition with few administrative requirements, at an interest rate that is 50 basis points above the FOMC's target rate for federal funds. Secondary credit may be provided to depository institutions that do not qualify for primary credit, subject to review by the lending Reserve Bank, at an interest rate that is 50 basis points above the rate on primary credit. Seasonal credit provides short-term funds to smaller depository institutions that experience regular seasonal swings in loans and deposits. The interest rate on seasonal credit is a floating rate based on market funding rates.

On September 28, 2012, the Federal Reserve began the regular publication of detailed information on individual discount window loans. In accordance with the Dodd-Frank Act, this information will be made available on a quarterly basis and with an approximately two-year lag. The disclosure includes the name and identifying details of the depository institution, the amount borrowed, the interest rate paid, and information identifying the types and amount of collateral pledged. This detailed information supplements the extensive aggregate information the Federal Reserve has previously provided in weekly, monthly, and quarterly reports, and is available on the Federal Reserve's public website at www.federalreserve.gov/newsevents/reform_quarterly_transaction.htm. 

During the financial crisis, the Federal Reserve modified the terms and conditions of the discount window lending programs in order to promote orderly market functioning. Information about these actions is available on the Federal Reserve's public website at www.federalreserve.gov/monetarypolicy/bst_lendingdepository.htm and www.frbdiscountwindow.org.

In extending credit through the discount window, the Federal Reserve closely monitors the financial condition of depository institutions utilizing a four-step process designed to minimize the risk of loss to the Federal Reserve posed by weak or failing borrowers. The first step is monitoring, on an ongoing basis, the safety and soundness of all depository institutions that access or may access the discount window and the payment services provided by the Federal Reserve. The second step is identifying institutions whose condition, characteristics, or affiliation would present higher-than-acceptable risk to the Federal Reserve in the absence of controls on their access to Federal Reserve lending facilities and other Federal Reserve services. The third step is communicating--to staff within the Federal Reserve System and to other supervisory agencies, if and when necessary--relevant information about those institutions identified as posing higher risk. The fourth step is implementing appropriate measures to mitigate the risks posed by such entities. 

At the heart of the condition-monitoring process is an internal rating system that provides a framework for identifying institutions that may pose undue risks to the Federal Reserve. The rating system relies mostly on information from each institution's primary supervisor, including CAMELS ratings, to identify potentially problematic institutions and classify them according to the severity of the risk they pose to the Federal Reserve.⁴ Having identified institutions that pose a higher risk, the Federal Reserve then puts in place a standard set of risk controls that become increasingly stringent as the risk posed by an institution grows; individual Reserve Banks may implement additional risk controls to further mitigate risk if they deem it necessary.

Collateral

All extensions of discount window credit by the Federal Reserve must be secured to the satisfaction of the lending Reserve Bank by "acceptable collateral." Assets accepted as collateral are assigned a lendable value deemed appropriate by the Reserve Bank; lendable value is determined as the market price of the asset, less a haircut. When a market price is not available, a haircut is applied to an internally modeled fair market value estimate. Haircuts reflect credit risk and, for traded assets, the historical volatility of the asset's price and the liquidity of the market in which the asset is traded; the Federal Reserve's haircuts are generally in line with typical market practice. A borrower may be required to pledge additional collateral if its financial condition weakens. Collateral is pledged by depository institutions under the terms and conditions specified in the Federal Reserve Banks' standard lending agreement, Operating Circular No. 10, available at www.frbservices.org/files/regulations/pdf/operating_circular_10.pdf.

Discount window loans are generally made with recourse to the borrower beyond the pledged collateral. Nonetheless, collateral plays an important role in mitigating the credit risk associated with these extensions of credit. The Federal Reserve generally accepts as collateral for discount window loans any assets that meet regulatory standards for sound asset quality. This category of assets includes most performing loans and most investment-grade securities, although for some types of securities (including commercial mortgage-backed securities, collateralized debt obligations, collateralized loan obligations, and certain non-dollar-denominated foreign securities) only very high-quality securities are accepted. An institution may not pledge as collateral any instruments that the institution or its affiliates have issued. To ensure that they can borrow from the Federal Reserve should the need arise, many depository institutions that do not have an outstanding discount window loan nevertheless routinely pledge collateral.

The Federal Reserve periodically reviews its collateral valuation practices. The most recent changes to the lending margins on discount window collateral took effect on October 19, 2009, and reflected the results of a broad-based review, which began before the financial crisis, of methodology and data sources. For more information on collateral margins, refer to the Discount Window and Payments System Risk public website, www.frbdiscountwindow.org. As presented in table 6, depository institutions that borrow from the Federal Reserve generally maintain collateral in excess of their current borrowing levels.

Liquidity Arrangements with Foreign Central Banks

Recent Developments

• Between February 27 and May 1, 2013, dollar liquidity extended under the central bank liquidity swap arrangements increased from $4.2 billion to $7.3 billion. As presented in table 7, all outstanding swaps are with the European Central Bank. Detailed information about swap operations is available at www.newyorkfed.org/markets/fxswap/fxswap.cfm.

Background

Because of the global character of bank funding markets, the Federal Reserve has at times coordinated with other central banks to provide liquidity. In December 2007, the Federal Reserve entered into agreements to establish temporary reciprocal currency arrangements (central bank liquidity swap lines) with the European Central Bank and the Swiss National Bank in order to provide liquidity in U.S. dollars. Subsequently, the FOMC authorized swap lines with the Reserve Bank of Australia, the Banco Central do Brasil, the Bank of Canada, the Bank of Japan, Danmarks Nationalbank, the Bank of England, the Bank of Korea, the Banco de Mexico, the Reserve Bank of New Zealand, Norges Bank, the Monetary Authority of Singapore, and Sveriges Riksbank. Two types of temporary swap lines were established: U.S. dollar liquidity swap lines and foreign currency liquidity swap lines. These temporary arrangements expired on February 1, 2010.

In May 2010, temporary U.S. dollar liquidity swap lines were re-established with the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank in order to address the re-emergence of strains in global U.S. dollar short-term funding markets. In December 2010, the FOMC authorized an extension of the arrangements through August 1, 2011. In June 2011, the FOMC authorized another extension of the arrangements through August 1, 2012. On November 30, 2011, the FOMC and these five foreign central banks (FCBs) agreed to reduce the rate on these swap arrangements from the U.S. dollar overnight index swap (OIS) rate plus 100 basis points to the OIS rate plus 50 basis points, and extended the authorization of these swap arrangements through February 1, 2013. In addition, as a contingency measure, the FOMC agreed to establish temporary bilateral liquidity swap arrangements with these five FCBs to provide liquidity in any of their currencies if necessary. In December 2012, the FOMC and these five FCBs authorized an extension of the temporary U.S. dollar liquidity swap lines and the network of temporary bilateral liquidity swap arrangements through February 1, 2014.

The FRBNY operates the swap lines under the authority granted under Section 14 of the Federal Reserve Act and in compliance with authorizations, policies, and procedures established by the FOMC.

U.S. Dollar Liquidity Swaps

U.S. dollar liquidity swaps consist of two transactions. When an FCB draws on its swap line with the FRBNY, the FCB transfers a specified amount of its currency to the FRBNY in exchange for dollars at the prevailing market exchange rate. The FRBNY holds the foreign currency in an account at the FCB. The dollars that the FRBNY provides are then deposited in an account that the FCB maintains at the FRBNY. At the same time, the FRBNY and the FCB enter into a binding agreement for a second transaction that obligates the FCB to return the U.S. dollars and the FRBNY to return the foreign currency on a specified future date at the same exchange rate as the initial transaction. Because the swap transactions will be unwound at the same exchange rate used in the initial transaction, the recorded value of the foreign currency amounts is not affected by changes in the market exchange rate. At the conclusion of the second transaction, the FCB compensates the FRBNY at a market-based interest rate.

When the FCB lends the dollars it obtained by drawing on its swap line to institutions in its jurisdiction, the dollars are transferred from the FCB account at the FRBNY to the account of the bank that the borrowing institution uses to clear its dollar transactions. The FCB is obligated to return the dollars to the FRBNY under the terms of the agreement. Neither the FRBNY nor the Federal Reserve is counterparty to the loan extended by the FCB. The FCB bears the credit risk associated with the loans it makes to institutions in its jurisdiction.

The foreign currency that the Federal Reserve acquires in these transactions is recorded as an asset on the Federal Reserve's balance sheet and is shown in tables 1, 8, and 9 of the weekly H.4.1 statistical release in the line entitled "Central bank liquidity swaps." U.S. dollar liquidity swaps have maturities ranging from overnight to three months. Table 2 of the H.4.1 statistical release reports the maturity distribution of the outstanding U.S. dollar liquidity swaps. Detailed information about drawings on the swap lines by the participating FCBs is presented on the FRBNY's website at www.newyorkfed.org/markets/fxswap.

Foreign Currency Liquidity Swap Lines

On April 6, 2009, the FOMC announced foreign currency liquidity swap lines with the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank. These lines were designed to provide the Federal Reserve with the capacity to offer liquidity to U.S. institutions in foreign currency should a need arise. These lines mirrored U.S. dollar liquidity swap lines, which provide FCBs with the capacity to offer U.S. dollar liquidity to financial institutions in their jurisdictions. Under the foreign currency liquidity swap lines established in April 2009, the Federal Reserve had the ability to provide foreign currency-denominated liquidity to U.S. institutions in amounts of up to £30 billion (sterling), €80 billion (euro), ¥10 trillion (yen), and CHF 40 billion (Swiss francs). The Federal Reserve did not draw on these swap lines, and they expired on February 1, 2010.

In November 2011, as a contingency measure, the FOMC agreed to establish temporary bilateral foreign currency liquidity swap arrangements with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank so that liquidity can be provided in any of their currencies if necessary. The swap lines are authorized until February 1, 2014. So far, the Federal Reserve has not drawn on these swap lines. Additional information is available at www.newyorkfed.org/markets/liquidity_swap.html.

References

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