“Bank holdings of Treasurys rose by $71 billion in the third quarter, to $345 billion, according to last week’s quarterly banking profile from the Federal Deposit Insurance Corp. That 26% upswing from the previous quarter marked the fourth consecutive quarter of double-digit-percentage growth in bank Treasury portfolios…

…What’s more, Treasurys now comprise a larger portion of total bank assets than at any point in this century. This is a tectonic shift—and, because yields on Treasurys are so low, it is one that likely will weigh on earnings. So why have banks developed such a voracious appetite for low-yielding U.S. government debt? The most likely catalyst is the need to begin complying with a new type of bank liquidity rules. This will require the biggest U.S. banks to hold a portfolio of assets that could be easily sold to make up for cash outflows in a stress period that lasted 30 days. The rule will start phasing in early next year. Alongside the Federal Reserve’s stress-test capital-planning program, the liquidity requirement is one of the most novel innovations in postcrisis bank supervision. The idea is to force banks to self-insure against liquidity stress instead of relying on emergency lending from the Fed.”, John Carney, “Banks Drink Deep From Uncle Sam’s Debt Fountain”, Wall Street Journal

“It almost seems like the Fed used this new liquidity requirement, and its timing, to force the Big Banks to take over their QE purchase role?”, Mike Perry, former Chairman and CEO, IndyMac Bank

Heard on the Street

Banks Drink Deep From Uncle Sam’s Debt Fountain

New Liquidity Rules Send Banks Scrambling for U.S. Debt

Treasurys now comprise a larger portion of total bank assets than at any point in this century. The U.S. Treasury Building in Washington. Getty Images

By John Carney

America’s banks are gobbling up U.S. government debt.

Bank holdings of Treasurys rose by $71 billion in the third quarter, to $345 billion, according to last week’s quarterly banking profile from the Federal Deposit Insurance Corp. That 26% upswing from the previous quarter marked the fourth consecutive quarter of double-digit-percentage growth in bank Treasury portfolios. What’s more, Treasurys now comprise a larger portion of total bank assets than at any point in this century. This is a tectonic shift—and, because yields on Treasurys are so low, it is one that likely will weigh on earnings.

The downward pressure is exacerbated by the fact the change appears to be the result of a move away from higher-yielding assets in banks’ securities portfolios. And those portfolios have become increasingly central to banks in recent years, now making up over 20% of their total assets.

So why have banks developed such a voracious appetite for low-yielding U.S. government debt? The most likely catalyst is the need to begin complying with a new type of bank liquidity rules. This will require the biggest U.S. banks to hold a portfolio of assets that could be easily sold to make up for cash outflows in a stress period that lasted 30 days. The rule will start phasing in early next year.

Alongside the Federal Reserve’s stress-test capital-planning program, the liquidity requirement is one of the most novel innovations in postcrisis bank supervision. The idea is to force banks to self-insure against liquidity stress instead of relying on emergency lending from the Fed.

To account for the fact that some assets are more easily sold in a liquidity crunch than others, regulators impose haircuts on assets banks can use to meet the new requirements. Corporate bonds, for example, get a 50% haircut, so that a $1 billion bond would make up for just $500 million of assumed cash outflows.

Banks only get full credit for holding obligations backed by the full faith and credit of the U.S. That is pretty much limited to Treasurys and Ginnie Mae mortgage securities.

Perhaps even more important, these have to make up at least 60% of the liquidity portfolio. That combination is what is fueling the banks’ demand for Treasurys.

One silver lining: Additional liquidity should make banks less vulnerable to downturns. That means that on a risk-adjusted basis, any decline in returns on assets may not be as severe as it first appears.

Posted on December 2, 2014, in Postings. Bookmark the permalink. Leave a comment.

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