The article explains it pretty well, but it’s hard to understand which are the important bits without having done a lot of background research.
The main idea is that bank regulation and fiscal/monetary policy are often at odds with one another. The article mentions the SLR, which is supposed to reduce systemic risk by enforcing minimum capital requirements. Importantly, deposits are part of the denominator—they are liabilities of the bank. So flooding the banking system with cash (e.g. pandemic relief) will force banks to raise capital to maintain compliance with SLR.
The Fed could see this coming and relaxed the SLR requirements at first, but this temporary measure expired in March 2021 and within a matter of months the Fed’s reverse repo had swelled to nearly $2T. Reverse repo can be complicated to explain but basically it is the Fed’s version of an overnight money market fund—we take your cash and give you highly liquid securities and then buy them back at a slight premium tomorrow, so you earn a return for the risk of holding those securities overnight.
To reiterate, the only reason this facility exists is because banking regulations punish banks for holding excess deposits. If that was not the case, then the Fed could just pay interest directly on reserves to set a floor on interbank lending rates.
The main idea is that bank regulation and fiscal/monetary policy are often at odds with one another. The article mentions the SLR, which is supposed to reduce systemic risk by enforcing minimum capital requirements. Importantly, deposits are part of the denominator—they are liabilities of the bank. So flooding the banking system with cash (e.g. pandemic relief) will force banks to raise capital to maintain compliance with SLR.
The Fed could see this coming and relaxed the SLR requirements at first, but this temporary measure expired in March 2021 and within a matter of months the Fed’s reverse repo had swelled to nearly $2T. Reverse repo can be complicated to explain but basically it is the Fed’s version of an overnight money market fund—we take your cash and give you highly liquid securities and then buy them back at a slight premium tomorrow, so you earn a return for the risk of holding those securities overnight.
To reiterate, the only reason this facility exists is because banking regulations punish banks for holding excess deposits. If that was not the case, then the Fed could just pay interest directly on reserves to set a floor on interbank lending rates.