Profiling of institutional cash pools

 Profiling of institutional cash pools

Through the profiling of institutional cash pools, this paper explains the rise of the "shadow" banking system from a demand-side perspective. Explaining the rise of shadow banking from this angle paints a very different picture than the supply-side angle that views it as a story of banks’ funding preferences and arbitrage. Institutional cash pools prefer to avoid too much unsecured exposure to banks even through insured deposits. Short-term government guaranteed securities are the next best choice, but their supply is insufficient. The shadow banking system arose to fill this vacuum. One way to manage the size of the shadow banking system is by adopting the supply management of Treasury bills as a macroprudential tool.

Excerpts

"...institutional cash pools prioritize principal safety and portfolio diversification over yield and are hesitant (in many cases due to fiduciary reasons) to take on too much direct, unsecured exposures to banks through even insured deposits. In other words, institutional cash pools are not particularly keen on being intermediated through the traditional banking system."

"In the present context, Treasury bills (or more broadly, short-term government guaranteed instruments) are like gold. Just as in the 1960s there were too many dollars relative to U.S. gold reserves, today there is too much demand for safe, short-term and liquid instruments relative to the volume of (i) short-term, government guaranteed instruments; (ii) high-quality collateral to “manufacture” alternatives to short-term, government guaranteed instruments (see Bernanke (2011)); and (iii) capital to support the safety, short maturity and liquidity of such alternatives (see Acharya and Schnabl (2009)). All of these aspects have global dimensions:

First, one reason for the increase in the structural deficit of short-term, government guaranteed instruments is that reserve accumulation and foreign exchange management vis-àvis the dollar is primarily conducted by foreign central banks through the accumulation of U.S. government guaranteed securities, including short-term government guaranteed securities. However, these instruments are also the first-resort investment choice of cash pools.
Second, the high-quality collateral requirements associated with the manufacturing of alternatives to short-term government guaranteed instruments is also influenced by foreign central banks’ accumulation of long-term U.S. government guaranteed securities. For example, a shortage of Treasury bills can be filled by lending cash in a short-term repo transaction backed by longer-term Treasury notes. However, if the supply of high-quality term collateral becomes scarce, either (i) private alternatives (such as asset-backed securities and CDOs) will take their place (see Caballero (2009) and Bernanke (2011)), or (ii) the velocity of high-quality collateral will accelerate (see Singh (2011c, forthcoming)) if demand for the manufacturing of more safe, short-term and liquid instruments persists

Third, the transformation of term private collateral into safe, short-term, liquid instruments requires the performance of credit, maturity and liquidity transformation, which were conducted across a highly diverse set of institutions in the “shadow” banking system and backstopped by a diverse set of banks globally.

These examples demonstrate that not unlike the soaring volume of U.S. dollars relative to the volume of U.S. gold reserves stretched the convertibility of the dollar in the 1960s, the rise of institutional cash pools and their safety preferences stretched the U.S banking system to its limits in its ability to guarantee cash pools’ principal safety and redeemability on demand and at par and in unlimited amounts and in all states of the world. The U.S. banking system failed at a task no less than endogenously creating private alternatives to Treasury bills, that had the same degree of safety and liquidity than the real T-bills that were in short supply."

VIKASH KUMAR SINHA 

PGDM 2^ND

^PGDM/11/49