4. Funding Risks
Vulnerabilities from funding risks remained notable, reflecting challenges at some banks and structural vulnerabilities in other sectors engaged in liquidity transformation
The banking industry maintained a high level of liquidity since the October report. Funding risks for most banks remained low, and large banks that are subject to the liquidity coverage ratio (LCR) continued to maintain ample levels of high-quality liquid assets (HQLA). Deposit outflows stabilized over the second half of last year following the March 2023 banking-sector stresses and turned into inflows by the fourth quarter of 2023. Nevertheless, some banks continued to face funding challenges, including higher costs for funding and relatively high reliance on uninsured deposits. The Bank Term Funding Program (BTFP) ceased extending new loans on March 11, 2024.
Prime MMFs and similar cash-management vehicles remained a prominent source of vulnerability given their susceptibility to runs and the significant role they play in short-term funding markets. In addition, some cash-management vehicles, including retail prime MMFs, government MMFs, and short-term investment funds, maintained stable net asset values (NAVs) but may face difficulties doing so because they hold assets in their portfolios whose valuations are vulnerable to sharp movements in interest rates. Stablecoins are also prone to run risks like those of MMFs and other cash-management vehicles. However, the combined market capitalization of all stablecoins (roughly $150 billion currently) remained small relative to the broader funding markets, and stablecoins are not widely used as cash-management vehicles.
Some open-end bond mutual funds remained susceptible to large redemptions because they must allow shareholders to redeem every day even though the funds hold assets that can face losses and become illiquid amid stress. Life insurers continued to face funding risk owing to their reliance on a higher-than-average share of nontraditional liabilities in combination with an increasing share of illiquid and risky assets on their balance sheets.
Overall, estimated runnable money-like financial liabilities grew 8.8 percent to $21.3 trillion (75 percent of nominal GDP) over the past year, as a decline in uninsured deposits was more than offset by an increase in assets under management at MMFs. As a share of GDP, runnable liabilities remained above their historical median (table 4.1 and figure 4.1).
Table 4.1. Size of selected instruments and institutions
| Item | Outstanding/total assets (billions of dollars) |
Growth, 2022:Q4–2023:Q4 (percent) |
Average annual growth, 1997–2023:Q4 (percent) |
|---|---|---|---|
| Total runnable money-like liabilities1 | 21,348 | 9.0 | 4.8 |
| Uninsured deposits | 6,692 | −10.7 | 11.0 |
| Domestic money market funds2 | 5,822 | 24.3 | 6.0 |
| Government | 4,763 | 20.3 | 15.2 |
| Prime | 937 | 52.1 | 2.5 |
| Tax exempt | 123 | 11.2 | −1.3 |
| Repurchase agreements | 4,843 | 33.1 | 5.8 |
| Commercial paper | 1,235 | .6 | 2.6 |
| Securities lending3 | 811 | .8 | 6.8 |
| Bond mutual funds | 4,525 | 6.2 | 8.0 |
Note: The data extend through 2023:Q4 unless otherwise noted. Outstanding amounts are in nominal terms. Growth rates are measured from Q4 of the year immediately preceding the period through Q4 of the final year of the period. Total runnable money-like liabilities exceed the sum of listed components. Unlisted components of runnable money-like liabilities include variable-rate demand obligations, federal funds, funding-agreement-backed securities, private liquidity funds, offshore money market funds, short-term investment funds, local government investment pools, and stablecoins.
1. Average annual growth is from 2003:Q1 to 2023:Q4. Return to table
2. Average annual growth is from 2001:Q1 to 2023:Q4. Return to table
3. Average annual growth is from 2000:Q1 to 2023:Q2. Securities lending includes only lending collateralized by cash. Return to table
Source: Securities and Exchange Commission, Private Funds Statistics; iMoneyNet, Inc., Offshore Money Fund Analyzer; Bloomberg Finance L.P.; Securities Industry and Financial Markets Association: U.S. Municipal Variable-Rate Demand Obligation Update; Risk Management Association, Securities Lending Report; DTCC Solutions LLC, an affiliate of the Depository Trust & Clearing Corporation: commercial paper data; Federal Reserve Board staff calculations based on Investment Company Institute data; Federal Reserve Board, Statistical Release Z.1, "Financial Accounts of the United States"; Federal Financial Institutions Examination Council, Consolidated Reports of Condition and Income (Call Report); Morningstar, Inc., Morningstar Direct; Llama Corp, DeFiLlama.
Figure 4.1. Ratios of runnable money-like liabilities to GDP remained above their historical medians
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Note: The black striped area denotes the period from 2008:Q4 to 2012:Q4, when insured deposits increased because of the Transaction Account Guarantee program. The "other" category consists of variable-rate demand obligations (VRDOs), federal funds, funding-agreement-backed securities, private liquidity funds, offshore money market funds, short-term investment funds, local government investment pools, and stablecoins. Securities lending includes only lending collateralized by cash. GDP is gross domestic product. Values for VRDOs come from Bloomberg beginning in 2019:Q1. See Jack Bao, Josh David, and Song Han (2015), "The Runnables," FEDS Notes (Washington: Board of Governors of the Federal Reserve System, September 3), https://www.federalreserve.gov/econresdata/notes/feds-notes/2015/the-runnables-20150903.html.
Source: Securities and Exchange Commission, Private Funds Statistics; iMoneyNet, Inc., Offshore Money Fund Analyzer; Bloomberg Finance L.P.; Securities Industry and Financial Markets Association: U.S. Municipal Variable-Rate Demand Obligation Update; Risk Management Association, Securities Lending Report; DTCC Solutions LLC, an affiliate of the Depository Trust & Clearing Corporation: commercial paper data; Federal Reserve Board staff calculations based on Investment Company Institute data; Federal Reserve Board, Statistical Release Z.1, "Financial Accounts of the United States"; Federal Financial Institutions Examination Council, Consolidated Reports of Condition and Income (Call Report); gross domestic product, Bureau of Economic Analysis via Haver Analytics; Llama Corp, DeFiLlama.
Most banks maintained high levels of liquid assets and stable funding
Aggregate liquidity in the banking system appeared ample, as HQLA measured relative to total assets stabilized at most banks in the second half of 2023 (figure 4.2). Moreover, U.S. G-SIBs continued to hold more HQLA than required by their LCR—the requirement that ensures banks hold sufficient HQLA to fund estimated cash outflows for 30 days during a hypothetical stress event. While banks' reliance on short-term wholesale funding increased slightly over the second half of last year, the levels remained low relative to longer-term averages (figure 4.3).
Figure 4.2. The amount of high-quality liquid assets held by most banks stabilized in the second half of 2023
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Note: The sample consists of domestic bank holding companies (BHCs), intermediate holding companies (IHCs) with a substantial U.S. commercial banking presence, and commercial banks. G-SIBs are global systemically important banks. Large non–G-SIBs are BHCs and IHCs with greater than $100 billion in total assets that are not G-SIBs. Liquid assets are cash plus estimates of securities that qualify as high-quality liquid assets as defined by the Liquidity Coverage Ratio requirement. Accordingly, Level 1 assets as well as discounts and restrictions on Level 2 assets are incorporated into the estimate.
Source: Federal Reserve Board, Form FR Y-9C, Consolidated Financial Statements for Holding Companies.
Figure 4.3. Banks' reliance on short-term wholesale funding remained low
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Note: Short-term wholesale funding is defined as the sum of large time deposits with maturity less than 1 year, federal funds purchased and securities sold under agreements to repurchase, deposits in foreign offices with maturity less than 1 year, trading liabilities (excluding revaluation losses on derivatives), and other borrowed money with maturity less than 1 year. The shaded bars with top caps indicate periods of business recession as defined by the National Bureau of Economic Research: March 2001–November 2001, December 2007–June 2009, and February 2020–April 2020.
Source: Federal Reserve Board, Form FR Y-9C, Consolidated Financial Statements for Holding Companies.
Deposit flows have stabilized across most bank groups over the past six months, as market sentiment has improved following the banking-sector stresses in March 2023. However, key vulnerabilities that interacted to cause the regional banking crisis last spring—large fair value losses relative to regulatory capital and elevated reliance on uninsured deposits—remained elevated for a subset of banks.
The BTFP helped support the stability of the financial system and thereby American businesses and households, providing funding during the acute phase of the banking-sector stresses, and many depository institutions continued to rely on it over the past year. The box "The Bank Term Funding Program" summarizes how the BTFP was effective in helping banks to safeguard deposits while continuing to meet the credit needs of the economy over the past year.
Box 4.1. The Bank Term Funding Program
The banking system came under severe stress in March 2023. After experiencing deposit withdrawals of unprecedented speed, Silicon Valley Bank and Signature Bank collapsed on March 10 and March 12, respectively, when it became clear that they did not have sufficient liquidity to meet persistent and increasingly significant deposit outflows. The two failures generated broader concerns about destabilizing runs at other commercial banks with similar profiles—those with heavy reliance on uninsured deposits and large unrealized losses in their securities portfolios. Concerns over broader contagion led some of those banks to face rapid deposit outflows.
In response to the market turmoil, the Federal Reserve Board, the Federal Deposit Insurance Corporation (FDIC), and the U.S. Department of the Treasury took actions to protect bank depositors, support financial stability, and minimize the effect of stress in the banking system on businesses, households, taxpayers, and the broader economy.1 The Federal Reserve Board, with approval by the Secretary of the Treasury, established the BTFP pursuant to section 13(3) of the Federal Reserve Act.2
The BTFP provided depository institutions an additional source of liquidity against high-quality securities for them to meet the needs of all their depositors. The ability of depository institutions to access funding without selling securities at a loss during stress limited destabilizing runs and the associated potential for further contagion throughout the banking system. While the banking system saw deposit outflows of $472 billion in the first quarter of 2023, those outflows moderated to $99 billion in the second quarter and slowed further to $90 billion in the third quarter. Deposits in the banking system experienced inflows of $260 billion in the fourth quarter. Banks with total assets below $250 billion experienced the greatest deposit outflows in the first quarter; outflows fell off rapidly in the second quarter and turned to inflows in the third and fourth quarters.
Eligible BTFP borrowers included federally insured banks, savings associations, and credit unions, as well as U.S. branches and agencies of foreign banks that were eligible for primary credit under the Federal Reserve's discount window. The BTFP extended advances of up to one year against the par value of eligible collateral, consisting of securities that are eligible for purchase by the Federal Reserve in open market operations, such as U.S. Treasury securities, U.S. agency securities, and U.S. agency mortgage-backed securities, and were owned by the borrower as of March 12, 2023. Under the BTFP, no haircuts were applied to eligible collateral. The rate for advances was fixed for the duration of the advance at the one-year overnight index swap rate plus 10 basis points on the day the advance was made. The interest rate applicable to new BTFP advances was adjusted on January 24, 2024, to be no lower than the interest rate on reserve balances on the same day the advance was made.
As figure A shows, credit extended through the BTFP increased at a rapid pace initially, reaching a level above $60 billion by the end of March 2023. Credit extended continued to increase in subsequent months, although at a slower pace, surpassing $100 billion by the end of August 2023. Outstanding balances increased further in late 2023, surpassing $165 billion before gradually declining in early 2024. The BTFP ceased extending new loans, as scheduled, on March 11, 2024. Since its establishment, the BTFP extended advances to 1,804 depository institutions, of which 1,706, or 95 percent, were small institutions with total assets below $10 billion.3 Advances taken out on or before March 11, 2024, will mature, depending on the term requested by the borrower, up to one year from the date the advance was made and need not be repaid before the maturity date. As a result, the BTFP continues to provide liquidity to eligible depository institutions.
Figure A. Outstanding balances of the Bank Term Funding Program declined in early 2024
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Source: Federal Reserve Board, Statistical Release H.4.1, "Factors Affecting Reserve Balances," accessed via Federal Reserve Economic Data.
1. On March 12, 2023, the Secretary of the Treasury, after receiving a written recommendation from the FDIC's board of directors and the Federal Reserve Board, and consulting with the President, approved a systemic risk exception, enabling the FDIC to complete the resolution of Silicon Valley Bank and Signature Bank in a manner that fully protected all depositors. Return to text
2. With approval of the Secretary of the Treasury, the Treasury committed to make available up to $25 billion from the Exchange Stabilization Fund as a backstop for the BTFP. Return to text
3. More than 9,000 institutions were eligible to borrow from the BTFP. Return to text
Money market funds and other cash-management vehicles remained susceptible to runs owing to structural vulnerabilities
Assets managed by MMFs increased steadily since the October report, as MMFs continued to provide more attractive yields relative to most bank deposits (figure 4.4).
Figure 4.4. Assets under management at money market funds continued to rise
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Note: The data are converted to constant 2024 dollars using the consumer price index.
Source: Federal Reserve Board staff calculations based on Investment Company Institute data; consumer price index, Bureau of Labor Statistics via Haver Analytics.
On July 12, 2023, the SEC voted to adopt reforms for MMFs.10 Some key elements of the reforms—increased minimum requirements for funds' daily and weekly liquid assets and elimination of temporary gates and fees linked to liquid asset levels—are already in effect. Mandatory dynamic liquidity fees for institutional prime and institutional tax-exempt funds will go into effect later this year. On net, the reforms represent significant progress in making prime and tax-exempt MMFs more resilient, although these funds remain vulnerable to runs in periods of significant stress.
Other cash-management vehicles, such as dollar-denominated offshore MMFs and short-term investment funds, also invest in money market instruments, engage in liquidity transformation, and are vulnerable to runs. Since the October report, estimated aggregate assets under management (AUM) of these cash-management vehicles remained roughly at $1.8 trillion. Currently, between $0.6 trillion and $1.6 trillion of these vehicles' AUM are in portfolios like those of U.S. prime MMFs, and large redemptions from these vehicles also have the potential to destabilize short-term funding markets.11
Many cash-management vehicles—including retail and government MMFs, offshore MMFs, and short-term investment funds—seek to maintain stable NAVs that are typically rounded to $1.00. If short-term interest rates rise sharply or portfolio assets lose value for other reasons, the market values of these funds may fall below their rounded share prices, which can put the funds under strain, particularly if they also have large, concurrent redemptions.
Stablecoins remained vulnerable to runs
Stablecoin assets—digital assets designed to maintain a stable value relative to a national currency or another reference asset—grew steadily since the October report. The total market capitalization of stablecoins grew to around $150 billion (figure 4.5). While not widely used as a cash-management vehicle or for transactions for real economic activity, stablecoins are important for digital asset investors. Stablecoins remain structurally vulnerable to runs and lack a comprehensive prudential regulatory framework. Moreover, stablecoins could scale quickly, particularly if the stablecoin is supported by access to an existing customer base.
Figure 4.5. Market capitalization of major stablecoins increased slightly since late last year
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Note: The key identifies series in order from top to bottom.
Source: Llama Corp, DeFiLlama.
Bond mutual funds' asset holdings stabilized, but the funds remained exposed to liquidity risks
Mutual funds that invest substantially in corporate bonds, municipal bonds, and bank loans may be particularly exposed to liquidity transformation risks, given the relative illiquidity of their assets and the requirement that these funds offer redemptions daily. Despite some outflows amid rising interest rates since 2022, the outstanding amount of corporate bonds held by mutual funds remained high at approximately $1.3 trillion as of the fourth quarter of 2023, the latest data available, representing about 13 percent of corporate bonds outstanding (figure 4.6). Total AUM of the subcategories of mutual funds holding high-yield bonds and bank loans, which primarily hold riskier and less liquid assets, stabilized in recent months (figure 4.7). Bond and loan mutual funds also experienced negative returns and notable outflows during most of 2022, but outflows stabilized throughout last year and into early 2024 (figure 4.8).
Figure 4.6. Corporate bonds held by bond mutual funds remained stable in the second half of 2023
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Note: The data show holdings of all U.S. corporate bonds by all U.S.-domiciled mutual funds (holdings of foreign bonds are excluded). The data are converted to constant 2023 dollars using the consumer price index.
Source: Federal Reserve Board staff estimates based on Federal Reserve Board, Statistical Release Z.1, "Financial Accounts of the United States"; consumer price index, Bureau of Labor Statistics via Haver Analytics.
Figure 4.7. Assets held by bank loan and high-yield mutual funds stayed relatively flat through early 2024
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Note: The data are converted to constant 2024 dollars using the consumer price index. The key identifies series in order from top to bottom.
Source: Investment Company Institute; consumer price index, Bureau of Labor Statistics via Haver Analytics.
Figure 4.8. Flows have stabilized for bond and bank loan mutual funds
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Note: Mutual fund assets under management as of February 2024 included $2,263 billion in investment-grade bond mutual funds, $327 billion in high-yield bond mutual funds, and $79 billion in bank loan mutual funds. Bank loan mutual funds, also known as floating-rate bond funds, are excluded from high-yield bond mutual funds.
Source: Investment Company Institute.
Central counterparties' initial margin levels and prefunded resources remained high, even as interest rate volatility has moderated
Central counterparties' (CCP) initial margin levels remained high even as market volatility slightly decreased during the second half of 2023. CCPs also maintained high levels of prefunded resources. Elevated initial margins and ample overall prefunded resources work together to imply a relatively low vulnerability at CCPs to a potential default by a clearing member or market participant.12 These two factors also reduce the possibility of large liquidity demands from a CCP to its credit providers (banks). However, additional liquidity risk remains around the concentration of clients at the largest clearing members, which could make transferring client positions to other clearing members challenging if it were ever necessary.
Life insurers' nontraditional liabilities remained high
Over the past decade, the share of less liquid assets held on life insurers' balance sheets—including CRE loans, less liquid corporate debt, and alternative instruments—has gradually increased (figure 4.9). Over this same period, life insurers have continued to increase their nontraditional liabilities—including funding-agreement-backed securities and cash received through repurchase agreements and securities lending transactions (figure 4.10). These liabilities can create liquidity risk through withdrawals or the inability to roll over funding if invested proceeds are not appropriately matched. The steady decline in the liquidity of life insurers' assets in conjunction with growing nontraditional liabilities makes it potentially more difficult for life insurers to meet a sudden rise in withdrawals and other claims.
Figure 4.9. Life insurers continued to hold more risky, illiquid assets on their balance sheets
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Note: The data are converted to constant 2022 dollars using the consumer price index. Securitized products include collateralized loan obligations for corporate debt, private-label commercial mortgage-backed securities for commercial real estate (CRE), and private-label residential mortgage-backed securities and asset-backed securities (ABS) backed by autos, credit cards, consumer loans, and student loans for other ABS. Illiquid corporate debt includes private placements, bank and syndicated loans, and high-yield bonds. Alternative investments include assets filed under Schedule BA. P&C is property and casualty. The key identifies bars in order from top to bottom.
Source: Consumer price index, Bureau of Labor Statistics via Haver Analytics; Federal Reserve Board staff estimates based on data from Bloomberg Finance L.P. and National Association of Insurance Commissioners Annual Statutory Filings.
Figure 4.10. Life insurers continued to use nontraditional liabilities for funding
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Note: The data are converted to constant 2023 dollars using the consumer price index. FHLB is Federal Home Loan Bank. The data are annual from 2006 to 2010 and quarterly thereafter. The key identifies bars in order from top to bottom.
Source: Consumer price index, Bureau of Labor Statistics via Haver Analytics; Moody's Analytics, Inc., CreditView, Asset-Backed Commercial Paper Program Index; Securities and Exchange Commission, Forms 10-Q and 10-K; National Association of Insurance Commissioners, quarterly and annual statutory filings accessed via S&P Global, Capital IQ Pro; Bloomberg Finance L.P.
References
10. See U.S. Securities and Exchange Commission (2023), "SEC Adopts Money Market Fund Reforms and Amendments to Form PF Reporting Requirements for Large Liquidity Fund Advisers," press release, July 12, https://www.sec.gov/news/press-release/2023-129. Return to text
11. Cash-management vehicles included in this total are dollar-denominated offshore MMFs, short-term investment funds, private liquidity funds, ultrashort bond mutual funds, and local government investment pools. Return to text
12. Prefunded resources represent financial assets, including cash and securities, transferred by the clearing members to the CCP to cover that CCP's potential credit exposure in case of default by one or more clearing members. These prefunded resources are held as initial margin and prefunded mutualized resources, which builds the resilience of CCPs to the possible default of a clearing member or market participant. Return to text