President Laurie Logan’s Speech
Thank you for the kind introduction, Emily. It’s great to see everyone here for the 3rd Annual District 11 Banking Conference.
I’m excited about the chance to bring together bankers, regulators, and others to discuss important issues like the current state of banking, ways to combat fraud, and how we can better integrate with service providers. We have events like this to engage with stakeholders in banking and really get a grasp on the current situation. Once again, we’re proud to partner with the Texas Department of Banking for this event. Thanks for being part of this vital conversation.
District 11 has a variety of banks, and their representation here is significant. From large national institutions to small regional banks that serve their local communities, each plays a crucial role in the American economy. A diverse banking ecosystem bolsters our economy. Families and businesses have options to find the bank that fits their needs. Community banks understand the local dynamics better; I’ve seen this personally growing up in a small town in Kentucky. But then again, larger banks can provide the extensive services some customers require. Competition drives all banks to improve their service to the economy, and that’s a priority for us.
It’s also essential to note that the Federal Reserve is a bank too. While we don’t deal directly with deposits or loans for Main Street individuals or businesses, we support commercial banks, helping them serve their customers more effectively.
The Federal Reserve is the largest bank in the country, with $6.7 trillion in assets—accounting for about 21% of the nation’s GDP, which has decreased from the 35% peak seen during the pandemic. Even after the Federal Open Market Committee finished normalizing the balance sheet by adjusting pandemic-related assets, we remain above the pre-pandemic level of 19%.
This expansion of the balance sheet has led to a lot of discussion about its size and how to manage it. I’d like to share my thoughts on those points, though they are solely my own and not representative of the entire Federal Reserve’s view.
In my perspective, just like all of the Fed’s activities, our balance sheet should prioritize public service and support for a robust economy. We need to be smart about how we use our balance sheet; there’s nothing wrong with growing it if it benefits society, but we shouldn’t let it become a hindrance to our mission.
The necessary size of the Fed’s balance sheet is influenced primarily by the demand for debt, including currency and reserves. We’re always there to provide liquidity beyond what’s demanded, but failure to meet demand can create financial strains. Currently, around $2.4 trillion is in currency and about $3 trillion in bank reserves, with the Treasury General Account nearing $1 trillion. While currency is rising alongside GDP, proportions of foreign reserves and the TGA in terms of GDP are larger than they were before the pandemic and the global financial crisis.
A recent essay I co-authored with colleague Sam Schulhofer Wall explores the Federal Reserve’s debt and its efficacy in public service. One takeaway is particularly relevant to you as bankers: reserves.
Let me provide some context on how the Fed manages reserves. Since 2008, we’ve employed a monetary policy focused on abundant foreign exchange reserves. This approach pays interest on reserves close to the market rate, ensuring sufficient reserves to meet bank demand. Changes in FOMC monetary policy also require adjustments in market interest rates, which the Fed manages by altering reserve interest rates.
Prior to 2008, our approach provided limited reserves and did not pay interest, forcing banks to hold reserves at significant costs. Thus, the term “rare” emerged.
Back to the Fed’s balance sheet: there are a couple of primary ways to reduce the current $3 trillion in reserves. One option is lowering banks’ reserve requirements; this would adjust the demand curve inward. Alternatively, we could revert to a deficit model, cutting reserve supplies to raise interest rates significantly above what we pay on banks’ marginal reserves.
A comparison of these methods shows that shifting the demand curve inward by reducing the need for reserves is preferable. U.S. dollar reserves are among the safest and most liquid assets globally, essential for banks to manage liquidity risks efficiently. With the interest on the assets backing reserves matching what’s paid to banks, it costs the Fed little to meet reserve requirements.
Overall, the existing reserve framework is both effective and efficient, stabilizing money market rates within the FOMC’s target range for nearly two decades without penalizing banks for maintaining safe assets. Making banks pay a premium for reserves would increase systemic risk.
If we were to pull back on interest payments on reserves, banks might face major challenges in predicting reserve demand and controlling interest rates, leading to costly consequences. A proposal to create reserve quotas could help stabilize demand and reduce costs, but it risks encroaching on market dynamics, potentially hindering innovation and competition.
Thus, I advocate for strategies that decrease the need for reserves.
The method of doing this matters significantly—some approaches are just more effective than others. For instance, banks often hold extra reserves for regulatory reasons or supervision’s sake. Good regulation boosts safety in banking. However, certain liquidity regulations may unintentionally hinder the use of reserve buffers during crises, which doesn’t enhance safety and is, frankly, an inefficient use of our balance sheet. Vice Chair Michelle Bowman has highlighted ways to enhance liquidity rules, and I’m keen to see those discussions unfold.
Enhancing access to the Fed’s liquidity tools is another avenue. We currently offer support through discount windows and repo operations. If banks trust they can monetize assets through the Fed, they’re more likely to maintain fewer reserves and seek other assets.
We’ve made strides in improving access to these tools, allowing online requests for loans and streamlining collateral processes. I believe there’s potential to further refine accessibility through measures like central clearers and daily discount auctions. We’re eager for continued input on how we can improve.
By shifting demand curves through these measures, I truly believe we can cut reserves while still enjoying the benefits of a robust reserves framework. There’s much more to the Fed’s balance sheet than I can cover today, and gradual changes are crucial. For a detailed read, please check our full analysis on the Dallas Fed website.
Now, I want to shift gears and welcome Robert Halsey, the CEO of American National Bank in Terrell, Texas, to the stage. We’re fortunate to have his insights on the Dallas Fed Board of Directors. While I’ve focused heavily on the Fed’s balance sheet, I’m eager to hear his take on the economic outlook and FOMC policy decisions. I suspect he’ll have some interesting questions to pose. Let’s give a warm welcome to Robert!
