Fed Watching How Monetary Policy Affecting Bank Liquidity, Quarles Says

As the Federal Reserve slowly normalizes it balance sheet, including reducing reserve balances, policymakers are watching closely for possible effects on large bank liquidity, Fed Vice Chairman for Supervision Randal Quarles said on Friday. Quarles noted that it is uncertain how banks’ demand for high-quality liquid assets — as required under the Liquidity Coverage Ratio — might affect banks’ demand for reserve balances.

Specifically, Quarles emphasized that the Fed will be carefully watching what other HQLA-eligible assets banks will substitute as reserve balances decline, as well as the volume and composition of deposits. “Overall, policymakers will be monitoring to make sure that the level of reserves the Fed supplies to the banking sector, which influences the composition of assets and liabilities on banks’ balance sheets as well as market interest rates, provides the desired stance of monetary policy to achieve the [Federal Open Market Committee]’s dual mandate of maximum employment and stable prices,” he said.

Quarles cited recent research by Fed staff showing “a significant degree of heterogeneity” in how banks comply with the LCR. “There likely is no single ‘representative bank’ behavioral model that can capture all we might want to know about banks’ demand for central bank reserve balances,” he noted, emphasizing the importance of careful monitoring.