Bank Reserves Part 1; The Great Tease 

Since we've already cracked open the accounting, it makes some sense to take our example into an important corollary examination (if you haven't yet, you'll need to read through Part 1). In our prior examples, we've assumed that the swap of risk-free assets on Bank A's asset side is a neutral trade. That is, there aren't any costs or downside associated with FRBNY's purchase. This may not necessarily be true.

In our previous example, I assumed Bank A was a traditional depository institution funded by deposits alone (with a small amount of owner's capital). Those kinds of firms don't much exist anymore at least in these places we are examining. A more realistic version is as presented in Figure 2-1 (though, again, using a stylized example of it).

Things get a little more complicated if you are swapping MBS assets for bank reserves in this situation. After all, if Bank A is funded on the liability side by wholesale techniques including repo (or even FX), that requires utilizing securities in inventory on the asset side for collateral. If they've disappeared into FRBNY's SOMA holdings, then your ability to mobilize collateral in repo is diminished and that necessity isn't in any way offset by the increase in bank reserves. Your job in funding is that much harder (made even more difficult by the near total collapse of unsecured interbank funding as alternative).

In all likelihood, now you will have to borrow securities from someone else (or, in more extreme but common cases, engage in collateral transformation). That someone else could include FRBNY itself, who through the RRP has made some of its SOMA holdings available for rent.

And if one or several of the various QE's takes your UST holdings, too, then repo becomes really challenging. In that way, QE could have been effective QT. In other words, what was supposed to have been “easing” might have been instead “tightening” at least in the repo market. Bank reserve assets are not perfect substitutes for other forms of risk-free securities. They are far less dynamic, which is why I characterize them as comparatively inert (and ultimately useless).