The Fed has recently stepped in to ameliorate repo market volatility; however, the structural issues leading U.S. banks to hoard cash seems likely to persist, according to a new dashboard report from Fitch Ratings. This may continue to present challenges for the Fed in assessing the level of reserves required to implement monetary policy under the ample reserves operating framework.

"A confluence of post-crisis capital, liquidity and supervision changes encouraged the largest U.S. banks to hoard liquidity, instead of repoing excess reserves into the market when SOFR exceeded the Fed Funds rate. We don't expect changes to these regulations anytime soon," said Monsur Hussain, senior director, Fitch Ratings.

The Bank of International Settlements (BIS) recently argued that the removal of large U.S. banks as marginal lenders against volatile repo market demand, and the short-term build-up of cash by the U.S. Treasury, all likely exacerbated the recent U.S. repo market volatility.

Since the financial crisis, total reserve balances held at the Fed in excess of regulatory requirements have increased significantly as a result of the Fed's balance sheet policy, peaking at $2.75 trillion, dominated by the U.S. G-SIBs. Conversely daylight overdrafts (DO) use peaked pre-crisis at almost $190 billion, but has fallen steeply to around $10 billion. The G-SIBs' hoarding has also appeared to weaken the link between the Fed Funds rate and the Secured Overnight Funding Rate (SOFR). This is because banks do not appear to be lending into the repo markets when the SOFR rises above the Fed Funds rate.

Fitch believes that post-crisis capital liquidity and resolution rules - primarily mandatory stress testing regimes, the 2014 Enhanced Prudential Standards (EPS) and the 2016/2017 Resolution Planning guidance- have contributed to the largest U.S. banks hoarding more cash at the Fed. The EPS and resolution stress testing includes a minimum operating liquidity (MOL) metric, requiring larger banks to have sufficient liquidity to continue operations during stress, which is tied to intraday liquidity usage. By "over-reserving," or holding cash at the Fed multiples in excess of intraday needs, the systemically important U.S. banks ensure they have sufficient unencumbered liquid assets to absorb any significant economic shocks.

"Banks may be reluctant to incur DOs as this could be interpreted negatively, causing reputational or political concerns, particularly for the largest U.S. banks," added Christopher Wolfe, Head of North American Banks.

In addition, the BIS also said volatile shifts in repos between money market funds to leveraged hedge funds, and the U.S. Treasury's efforts to rebuild its cash at the Fed, likely exacerbated the repo market volatility. This served to reduce U.S. GSIBs cash buffers and ability to lend cash.