## 1. The Secular Rise of Institutional Cash Pools

## Source details

**Canonical URL:** [1. The Secular Rise of Institutional Cash Pools](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2011/_wp11190.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2011/_wp11190.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2011/_wp11190.pdf.json)

---

### Introduction and purpose
- Asks why the bulk of institutional cash pools are not invested directly in deposits in the traditional banking system but in deposit alternatives and primarily in the so-called “shadow” banking system.
- Analyzes the portfolio allocation rationale of institutional cash pools to better understand the systemic risks inherent in their allocations.
- First study (to the author’s knowledge) treating institutional cash pools as a distinct phenomenon and connecting their rise to the growth of wholesale funding markets and implications for an official safety net limited to banks and deposits.

### Two added dimensions to safe-asset literature and conceptual linkage
- Distinguishes demand for long-term AAA assets from demand for short-term AAA assets; refers to demand for short-term AAA assets as demand for insured deposit alternatives.
- Expands focus from foreign central banks’ demand for long-term AAA assets to U.S.-domiciled, globally active non-financial corporations’ and U.S.-domiciled institutional investors’ demand for short-term AAA assets.
- Frames institutional cash pools’ demand for short-term AAA assets as the flipside of foreign central banks’ demand for long-term AAA assets and the principal source of marginal demand for maturity transformation in the financial system.

### Five main conclusions
- First: insured deposit alternatives dominate institutional cash pools’ investment portfolios relative to deposits; principal reason is search for principal safety and liquidity (not search for yield).
- Second: between 2003 and 2008, institutional cash pools’ demand for insured deposit alternatives exceeded the outstanding amount of short-term government guaranteed instruments not held by foreign official investors by a cumulative of at least $1.5 trillion; the “shadow” banking system rose to fill this gap.
- Third: institutional cash pools’ preferred habitat is not deposits, but insured deposit alternatives — i.e., institutional cash pools’ money demand is satisfied by non-M2 types of money because their needs (liquidity, collateral management, investing) are better met by Treasury bills and repos.
- Fourth: as larger institutional cash pools and their demand for insured deposit alternatives grow relative to the supply of short-term government guaranteed instruments, deposit insurance and lender-of-last-resort access for banks only become less effective stabilizers in crises.
- Fifth: a policy option is to issue more Treasury bills and explicitly incorporate supply management of bills into the macroprudential toolkit; this is posited as less troublesome than intense real-time monitoring and regulation of the shadow banking system.

*Terminology preserved: “insured deposit alternatives”, “non-M2 types of money”, links to “maturity transformation” and “shadow” banking system.*

### Measurement, drivers, and scale
- Institutional cash pools defined as large, centrally managed, short-term cash balances of global non-financial corporations and institutional investors (asset managers, securities lenders, pension funds).
- Secular drivers since the 1990s:
  - Globalization: rise of large, global corporations and centrally managed corporate cash pools.
  - Rise of asset management: centralized liquidity management of mutual funds, separate accounts and hedge funds; rise of securities lending and cash collateral reinvestment pools.
  - Rise of derivatives-based investment styles: futures-based duration positioning, liability-driven investing and synthetic ETFs overlaying derivatives onto cash pools.
- Size and historical growth:
  - Rose from $100 billion in 1990 to over $2.2 trillion at their peak in 2007.
  - Stood at $1.9 trillion during the fourth quarter of 2010.
  - Conservative augmented estimates (including additional cash-pool types) raise totals to $3.8 trillion in 2007 and $3.4 trillion in 2010.
- Typical pool characteristics:
  - Large (typically at least $1 billion; in some cases over $100 billion).
  - Central management by a single decision maker across many legal persons.
  - Examples at 2007 peak: most cash-rich corporations averaged $15 billion; long-term mutual funds averaged $20 billion per large asset manager; securities lenders’ cash collateral reinvestment pools averaged $75 billion per securities lender.
  - Regulated migration of OTC derivatives to CCPs estimated to add $200 billion to wholesale cash pools.

### Investment preferences, structural frictions, and allocation responses
- AFP Liquidity Surveys proxy (nearly 340 institutions; paper uses responses from institutions with annual revenues of over $1 billion — 43% of respondents):
  - Over 90% of institutional cash pools subject to written cash investment policies.
  - Stated priority order: (i) safety of principal; (ii) liquidity; and (iii) yield.
- Frictions with deposit intermediation:
  - Not enough banks to spread average pools in insured, $100,000 increments (pre-crisis deposit insurance limit).
  - Deposit insurance limit unchanged at $100,000 since 1980.
  - FDIC-insured banks shrank from 15,000 banks to 8,000 between 1990 and 2010.
  - Top ten banks’ share of system assets trebled from around 20% to 55% over the same period.
  - Additional constraints: only a subset of banks need funding at a given time; consolidated unsecured exposure limits; tax and operational considerations (e.g., offshore cash).
- Alternatives as slicing across banks became infeasible:
  - (i) Hold uninsured deposits (become uninsured, unsecured creditors to banks); or
  - (ii) Invest in insured deposit alternatives:
    - (ii/a) short-term government guaranteed instruments; or
    - (ii/b) privately guaranteed instruments (secured instruments and money funds) issued by the “shadow” banking system.
- Supply shortfall of government-guaranteed instruments: shortages of $1.1, $1.6 and $1.6 trillion in 2005, 2006 and 2007, respectively; increasing foreign official holdings since 2000 exacerbated the shortage.
- Resultant allocation choices:
  - Direct holdings of secured, privately guaranteed instruments (repo, asset-backed commercial paper) substituting collateral for government guarantees.
  - Indirect holdings via prime money funds (primarily unsecured) using global portfolio diversification as a substitute for government guarantees.
  - Safety of private alternatives further enhanced by credit, liquidity and brand puts provided by deposit-funded banks and bankruptcy exemptions — effectively making deposit-funded banks the ultimate guarantors of institutional cash pools’ principal.

### Cash equivalents, monetary aggregates, and habitat distinction
- Institutional cash portfolio allocations (2006–2008 survey period, pre-Lehman):
  - ~20% in bank deposits (likely insured exposures via deposit brokers/aggregators).
  - ~10% in short-term government guaranteed instruments.
  - ~60% in short-term, privately guaranteed instruments: ~20% in collateralized private money market instruments and nearly 40% in government-only and globally diversified prime money market mutual funds.
- Accounting vs official monetary aggregates:
  - FAS95 defines cash equivalents to include Treasury bills, commercial paper, asset-backed commercial paper, repurchase agreements and money market mutual funds.
  - Official U.S. monetary aggregates exclude many institutional cash equivalents: M1 includes demand and checkable deposits; M2 includes savings, small denomination time deposits (less than $100,000) and balances in retail-class money market mutual funds — but not institutional-class equivalents.
  - Conceptual problems: if retail-class money funds are included in M2, institutional-class money funds and related instruments arguably should be included.
- Broad money re-estimation (pre-Lehman):
  - Including a broader set of instruments would yield a total broad money aggregate of over $15 trillion and a private broad money aggregate of around $12 trillion, compared to official M2 of $8 trillion at the time.
- Habitat distinction:
  - Retail cash investors prefer insured, M2 instruments for transactions.
  - Wholesale cash investors prefer uninsured, non-M2 instruments for liquidity, collateral management and investing.
  - This divergence channels maturity transformation outside the traditional, M2-funded banking system.
- Pre-crisis near 1:1 relationship between institutional cash pools’ excess demand for short-term government-guaranteed instruments and rise in wholesale funding instruments (non-M2) issued by shadow banks.

### The Triffin dilemma of the U.S. banking system and crisis-era resolution
- Diagnosis:
  - Treasury bills viewed analogously to gold in a Triffin dilemma: excessive demand for safe, short-term instruments relative to supply strains the system.
  - Shortages exist in: (i) short-term government guaranteed instruments; (ii) high-quality collateral to manufacture alternatives; and (iii) capital to support safety, short maturity and liquidity of alternatives.
- Global dimensions:
  - Foreign reserve accumulation via U.S. government guaranteed securities reduces supply available for cash pools.
  - Accumulation of long-term U.S. government securities by foreign central banks affects availability of high-quality term collateral and can force substitution toward private collateral or accelerate collateral velocity.
  - Manufacturing safe, short-term instruments required credit, maturity and liquidity transformation across diverse shadow banking entities backstopped by diverse banks globally — explaining counterparty intensity and global reach of the shadow banking system.
- Evolutionary response:
  - Shadow banking and prime money funds evolved to allow institutional cash pools to attain counterparty diversification across many banks globally as the domestic bank universe concentrated.
- Crisis-era two-step “solution”:
  - Step 1: Federal Reserve assumed responsibility for credit and liquidity puts to privately issued insured deposit alternatives via a series of 13(3) lending facilities (taking over from banks).
  - Step 2: Supply of short-term government guaranteed instruments increased by $2 trillion as crisis intensified, enabling cash pools to trade from private alternatives into Treasury bills; Federal Reserve facilities provided funds to purchase newly issued short-term government guaranteed paper.
- Systemic implications:
  - Deposit-funded banks had been ultimate providers of par puts for institutional cash pools; provision of these puts strained bank solvency and propagated the 2007–2008 crisis.
  - Uninsured institutional cash pools at $3.5 trillion are comparable to households’ insured cash balances at ~$6 trillion (both as of 2011Q1).
  - Two decades earlier institutional uninsured pools were just over 5% of insured deposits; they account for over 55% of insured deposits today — raising concerns about banks’ ability to continue backstopping these pools and increased run-proneness.

### Policy alternatives (four broad permanent solutions)
- 1) Break-up of institutional cash pools.
  - Deemed least feasible; would require unprecedented “trust-busting” and sacrifice globalization and central management efficiencies.
- 2) Match Treasury bill issuance to volume and preferences of institutional cash pools.
  - Consider Treasury debt management tuned to size and duration preferences of cash pools.
  - Costs/trade-offs: (i) shift rollover risks to U.S. Treasury; (ii) shift focus away from optimizing national funding costs toward accommodating cash pool preferences; (iii) disengage a source of short-term funding from credit intermediation to the real economy.
  - Proposed as a promising macroprudential tool and operationally less cumbersome than direct regulation of the shadow banking system.
  - Greenwood, Hanson and Stein (2010) argued similarly for tilting issuance toward short maturities if private money creation has negative externalities.
  - Excess reserves and large-scale asset purchases are an alternative but less optimal for cash pools because exposures to reserves are indirect via banks.
- 3) Expand lender-of-last-resort access to non-banks that issue insured deposit alternatives.
  - Broadening access to entities such as broker-dealers (repo) and maturity transformation vehicles would involve the Fed more permanently in backstopping non-bank intermediaries; Fed crisis facilities were a temporary step.
- 4) Create new intermediary classes that issue deposit alternatives and bridge long-term assets to short-term cash pools.
  - New intermediaries funding in secured markets could replace runoff GSEs and shrinking agency discount note supply.
  - Without such bridges or more T-bills, expect increased issuance of products like collateralized commercial paper or putable CDs.

### Critique of contemporaneous reforms and targeted policy notes
- Critique:
  - Reforms have pushed banks away from short-term wholesale funding toward deposit funding without ensuring deposit demand exists.
  - Adjusted deposit insurance amounts on the margin and repealed Regulation Q under the assumption cash pools’ aversion to deposits was yield-driven.
  - Mandated money funds to market floating NAV shares without addressing cash pools’ need for diversification away from a concentrated U.S. banking system.
  - Such reforms, absent policies that explicitly address institutional cash pools, are likely to frustrate cash pools rather than satisfy them.
- Specific policy notes:
  - Issuing more Treasury bills would absorb liquidity represented by institutional cash pools and reduce the banking system’s burden of creating collateralized, levered private alternatives.
  - If more Treasury bills had been available pre-crisis, some risky assets might have been held in real money accounts rather than levered money market accounts, potentially reducing crisis severity.
  - Broadening Fed backstop to non-banks aligns with institutional cash pools’ preference to invest at a distance from banks in secured, non-M2 instruments.

### Regulation Q repeal, deposit insurance changes, and portfolio shifts (survey evidence)
- Portfolio allocations of institutional cash pools to deposits roughly doubled between June 2008 and June 2011, from 16% to 33%.
  - Shift driven by: the 150% increase in the FDIC’s maximum insurance amount from $100,000 to $250,000, and the temporary provision of unlimited insurance on noninterest-bearing transaction accounts.
- Despite repeal of Regulation Q effective July 21, 2011, further increases in allocations to deposits are unlikely:
  - June 2011 survey special question: 45% of institutional cash pools “have no plans to increase their balances held at their U.S. relationship banks as a result of the repeal of Regulation Q or unlimited insurance on transaction accounts though of 2012.”
- Safety considerations limiting further moves into deposits:
  - Noninterest-bearing transaction accounts fully insured up through December 31st, 2012 still represent direct, unsecured exposures with uncertainty about recovery timing after a bank’s bankruptcy; Treasury bills and repos considered safer and interest bearing alternatives, with repos offering more immediate and certain recoveries than insured deposits.
  - For interest-bearing transaction accounts, unlimited insurance will not apply; only the new standard maximum deposit insurance amount of $250,000 applies. Given average pool sizes and the number of FDIC-insured banks, higher insurance limits aren’t an efficient way to attain safety.
  - For interest-bearing non-transaction accounts (non-overnight institutional cash balances), the $250,000 deposit insurance limits do not appear sufficient to attain full safety; if a shortage of short-term, government guaranteed instruments exists, future leakage of funding into the “shadow” banking system is most likely to come from this maturity spectrum.

### Demand-side drivers and analogues
- Institutional cash pools prioritize principal safety and portfolio diversification over yield and are hesitant to take on too much direct, unsecured exposures to banks even through insured deposits; hence they are not keen on traditional banking intermediation.
- Between 2003 and 2008, cumulative demand for short-term government guaranteed instruments (as alternatives to insured deposits) exceeded supply by at least $1.5 trillion; shadow banking filled the vacuum by creating safe, short-term and liquid instruments.
- From the cash pools’ perspective, “shadow banking” can be viewed as market-based banking driven by portfolio diversification preferences.
- Central banks use market-based banking solutions: BIS manages nearly $250 billion in cash through products that transform portfolios of long-term G7 government bonds into safe, short-term and liquid instruments, used in part to avoid concentration at banks.

### Key statistics (as presented)
- Institutional cash pools size and timing:
  - $100 billion in 1990 → over $2.2 trillion peak in 2007 → $1.9 trillion in 2010Q4.
  - Conservative augmented totals: $3.8 trillion in 2007; $3.4 trillion in 2010.
  - Regulated migration to CCPs estimated to add $200 billion to wholesale cash pools.
- Shortfalls and shifts:
  - Shortage of government-guaranteed instruments: $1.1, $1.6 and $1.6 trillion in 2005, 2006 and 2007, respectively.
  - Between 2003 and 2008 cumulative excess demand over supply: at least $1.5 trillion.
  - Supply of short-term government guaranteed instruments increased by $2 trillion as crisis intensified.
- Monetary aggregates re-estimation:
  - Total broad money aggregate (including broader instruments) would be over $15 trillion; private broad money aggregate around $12 trillion; official M2 was $8 trillion (pre-Lehman reference period).
- Banking structure and concentration:
  - FDIC-insured banks: 15,000 (1990) → 8,000 (2010).
  - Top ten banks’ share of system assets: around 20% → 55% (trebled).
- Deposit insurance and portfolio shifts:
  - FDIC maximum insurance increased from $100,000 to $250,000 (a 150% increase).
  - Portfolio allocations to deposits: 16% (June 2008) → 33% (June 2011).
  - Survey response: 45% of cash pools “have no plans to increase their balances held at their U.S. relationship banks as a result of the repeal of Regulation Q or unlimited insurance on transaction accounts though of 2012.”
  - Noninterest-bearing transaction accounts fully insured up through December 31st, 2012.
- Comparative balances:
  - Uninsured institutional cash pools: $3.5 trillion (as of 2011Q1).
  - Households’ insured cash balances: ~$6 trillion (as of 2011Q1).
- BIS cash managed for central banks: nearly $250 billion.

*Source: _wp11190*

### 1. The Secular Rise of Institutional Cash Pools .......................................................................6

### 1. The Secular Rise of Institutional Cash Pools

### Introduction and purpose
- The paper asks why the bulk of institutional cash pools are not invested directly in deposits in the traditional banking system but in deposit alternatives and primarily in the so-called “shadow” banking system.
- It analyzes the portfolio allocation rationale of institutional cash pools to better understand the systemic risks inherent in their allocations.
- The paper is the first, to the best of the author’s knowledge, to study institutional cash pools as a distinct phenomenon and to connect their rise to the growth of wholesale funding markets and implications for the effectiveness of an official safety net limited to banks and deposits.

### Two added dimensions to existing safe-asset literature
- Differentiates between demand for long-term AAA assets (focus of Acharya and Schnabl (2009), Caballero (2010), Bernanke (2011)) and demand for short-term AAA assets (focus of the present paper).
- Expands the discussion from foreign central banks’ demand for long-term AAA assets to U.S.-domiciled, globally active non-financial corporations’ and U.S.-domiciled institutional investors’ demand for short-term AAA assets.
- Refers to demand for short-term AAA assets as demand for insured deposit alternatives.

### Conceptual linkage
- In the context of the global savings glut, institutional cash pools’ demand for short-term AAA assets is the flipside of foreign central banks’ demand for long-term AAA assets.
- Cash pools’ demand for short-term AAA assets is the principal source of marginal demand for maturity transformation in the financial system.

### Five main conclusions (verbatim framing)
- First, insured deposit alternatives dominate institutional cash pools’ investment portfolios relative to deposits. The principal reason for this is not search for yield, but search for principal safety and liquidity.
- Second, between 2003 and 2008, institutional cash pools’ demand for insured deposit alternatives exceeded the outstanding amount of short-term government guaranteed instruments not held by foreign official investors by a cumulative of at least $1.5 trillion; the “shadow” banking system rose to fill this gap. From this perspective, the rise of “shadow” banking has an under-appreciated demand-side dimension to it.
- Third, institutional cash pools’ preferred habitat is not deposits, but insured deposit alternatives. This is to say that institutional cash pools’ money demand is satisfied by non-M2 types of money. This is because institutional cash pools’ money demand is not for transaction purposes, but for liquidity and collateral management as well as investing purposes, which aren’t best met by deposits, but by Treasury bills and repos.
- Fourth, the larger institutional cash pools and their demand for insured deposit alternatives grows relative to the supply of short-term government guaranteed instruments in the financial system, the less effective deposit insurance and lender of last resort access for banks only will be as stabilizing forces in times of crises.
- Fifth, an elegant way to solve the financial system’s fragility due to the rise of institutional cash pools and “shadow” banking would be to issue more Treasury bills and to explicitly incorporate the supply management of bills into the macroprudential tool kit. While not without costs or alternatives, this approach is less troublesome and complicated than the alternative of intense real-time monitoring and regulation of the shadow banking system.

### Key analytic emphasis and terminology preserved
- “Insured deposit alternatives” is the term used for short-term AAA assets demanded by institutional cash pools.
- “Non-M2 types of money” is emphasized as the preferred habitat of institutional cash pools.
- The paper links institutional cash pools to “maturity transformation” and to the rise of the “shadow” banking system.

### Measurement and structure of the paper
- Section II measures the size of institutional cash pools in the non-financial corporate sector in the U.S. and globally, and among institutional investors in the U.S.
- Section III discusses the philosophy of how institutional cash pools attain security for their funds.
- Section IV discusses the portfolio allocation details of institutional cash pools and—in light of these details—highlights the gap between the accounting concept of cash equivalents and the scope of traditional monetary aggregates.
- The paper has six remaining sections beyond the Introduction.

*Source: _wp11190 - 1. The Secular Rise of Institutional Cash Pools*

### Section V discusses the U.S. banking system’s Triffin dilemma. Section VI provides policy

### _wp11190 - Section V discusses the U.S. banking system’s Triffin dilemma. Section VI provides policy

### Institutional cash pools — definition, drivers, and scale
- Institutional cash pools: large, centrally managed, short-term cash balances of global non-financial corporations and institutional investors such as asset managers, securities lenders and pension funds.
- Secular drivers since the 1990s:
  - Globalization: rise of large, global corporations and centrally managed corporate cash pools.
  - Rise of asset management: centralized liquidity management of mutual funds, separate accounts and hedge funds; rise of securities lending and cash collateral reinvestment pools.
  - Rise of derivatives-based investment styles: futures-based duration positioning, liability-driven investing and synthetic ETFs overlaying derivatives onto cash pools.
- Size and historical growth:
  - Rose from $100 billion in 1990 to over $2.2 trillion at their peak in 2007.
  - Stood at $1.9 trillion during the fourth quarter of 2010.
  - Conservative augmented estimates (including additional cash-pool types) raise totals to $3.8 trillion in 2007 and $3.4 trillion in 2010.
- Typical pool characteristics:
  - Large (typically at least $1 billion in size; in some cases over $100 billion).
  - Central management: single decision maker managing pooled balances across many legal persons.
  - Examples of average sizes at 2007 peak:
    - Most cash-rich corporations averaged $15 billion.
    - Long-term mutual funds averaged $20 billion per large asset manager.
    - Securities lenders’ cash collateral reinvestment pools averaged $75 billion per securities lender.
  - Regulated migration of OTC derivatives to CCPs estimated to add $200 billion to wholesale cash pools.

### Profiling institutional cash pools — investment preferences and structural frictions
- AFP Liquidity Surveys coverage and proxy:
  - Surveys of nearly 340 institutions; paper uses responses from institutions with annual revenues of over $1 billion (43% of respondents) to proxy institutional cash pool preferences.
  - Over 90% of institutional cash pools are subject to written cash investment policies.
  - Stated priority order of objectives: (i) safety of principal; (ii) liquidity; and (iii) yield.
- Frictions with deposit intermediation:
  - Not enough banks to spread average pools in insured, $100,000 increments (the pre-crisis deposit insurance limit).
  - Deposit insurance limit unchanged at $100,000 since 1980.
  - Between 1990 and 2010, FDIC-insured banks shrank from 15,000 banks to 8,000.
  - Top ten banks’ share of system assets trebled from around 20% to 55% over the same period.
  - Additional constraints: only subset of banks need funding at a given time; consolidated unsecured exposure limits; tax and operational considerations (e.g., offshore cash in low-tax jurisdictions).
- Alternatives faced by cash pools as slicing across banks became infeasible:
  - (i) Hold uninsured deposits (become uninsured, unsecured creditors to banks), or
  - (ii) Invest in insured deposit alternatives: (ii/a) short-term government guaranteed instruments; or (ii/b) privately guaranteed instruments (secured instruments and money funds) issued by the “shadow” banking system.
- Supply shortfall of government-guaranteed instruments:
  - Shortage amounted to $1.1, $1.6 and $1.6 trillion in 2005, 2006 and 2007, respectively.
  - Increasing foreign official holdings of short-term government-guaranteed instruments since 2000 exacerbated the shortage.
- Resultant allocation choices:
  - Direct holdings of secured, privately guaranteed money market instruments (e.g., repo, asset-backed commercial paper) where collateral substituted for government guarantees.
  - Indirect holdings via prime money funds (primarily unsecured) where global portfolio diversification substituted for government guarantees.
  - Safety of private alternatives further enhanced by credit, liquidity and brand puts provided by deposit-funded banks and bankruptcy exemptions — effectively making deposit-funded banks the ultimate guarantors of institutional cash pools’ principal.

### Cash equivalents and monetary aggregates — scope mismatch and implied aggregates
- Institutional cash portfolio allocations (2006–2008 survey period, pre-Lehman and pre-change in deposit insurance):
  - ~20% in bank deposits (likely insured exposures via deposit brokers/aggregators).
  - ~10% in short-term government guaranteed instruments.
  - ~60% in short-term, privately guaranteed instruments: ~20% in collateralized private money market instruments and nearly 40% in government-only and globally diversified prime money market mutual funds.
- Accounting vs monetary aggregates:
  - FAS95 defines cash equivalents to include Treasury bills, commercial paper, asset-backed commercial paper, repurchase agreements and money market mutual funds.
  - Official U.S. monetary aggregates exclude many institutional cash equivalents: M1 includes demand and checkable deposits; M2 includes savings, small denomination time deposits (less than $100,000) and balances in retail-class money market mutual funds — but not institutional-class equivalents.
  - Conceptual problems: if retail-class money funds are included in M2, then institutional-class money funds, securities lenders’ cash collateral pools, cash “plus” funds, enhanced cash, offshore money funds, ultra-short bond funds, and money ETFs arguably should be included.
- Broad money re-estimation (pre-Lehman):
  - Including the broader set of instruments would yield a total broad money aggregate of over $15 trillion and a private broad money aggregate of around $12 trillion, compared to official M2 of $8 trillion at the time.
- Habitat distinction:
  - Retail cash investors prefer insured, M2 instruments for transactions.
  - Wholesale cash investors (institutional pools) prefer uninsured, non-M2 instruments for liquidity, collateral management and investing.
  - Preferred habitat divergence channels maturity transformation outside the traditional, M2-funded banking system.
- Relationship between shortages and shadow banking:
  - Pre-crisis near 1:1 relationship between institutional cash pools’ excess demand for short-term government-guaranteed instruments and rise in wholesale funding instruments (non-M2) issued by shadow banks to fill the gap.

### The Triffin dilemma of the U.S. banking system — diagnosis and crisis-era resolution
- Analogy and problem statement:
  - Treasury bills (short-term government guaranteed instruments) viewed as analogous to gold in the classical Triffin dilemma: excessive demand for safe, short-term instruments relative to supply strains the system.
  - Shortages exist in: (i) short-term government guaranteed instruments; (ii) high-quality collateral to manufacture alternatives; and (iii) capital to support safety, short maturity and liquidity of alternatives.
- Global dimensions:
  - Foreign reserve accumulation by foreign central banks primarily conducted via U.S. government guaranteed securities reduces available supply of short-term instruments for cash pools.
  - Accumulation of long-term U.S. government securities by foreign central banks affects availability of high-quality term collateral and can force substitution toward private collateral or accelerate collateral velocity.
  - Manufacturing safe, short-term instruments required credit, maturity and liquidity transformation across diverse shadow banking entities backstopped by diverse banks globally — explaining counterparty intensity and global reach of the shadow banking system.
- Evolutionary response:
  - Shadow banking and prime money funds evolved to allow institutional cash pools to attain counterparty diversification across many banks globally as domestic bank universe concentrated.
- Crisis-era two-step “solution”:
  - Step 1: Federal Reserve assumed responsibility for credit and liquidity puts to privately issued insured deposit alternatives via a series of 13(3) lending facilities (taking over from banks).
  - Step 2: Supply of short-term government guaranteed instruments increased by $2 trillion as crisis intensified, enabling cash pools to trade from private alternatives into Treasury bills; Federal Reserve facilities provided funds to purchase newly issued short-term government guaranteed paper.
- Systemic implications:
  - Deposit-funded banks had been the ultimate providers of par puts for institutional cash pools; provision of these puts strained bank solvency and propagated the 2007–2008 crisis.
  - Uninsured institutional cash pools at $3.5 trillion are comparable to households’ insured cash balances at ~$6 trillion (both as of 2011Q1).
  - Two decades earlier institutional uninsured pools were just over 5% of insured deposits; they account for over 55% of insured deposits today — raising concerns whether banks can continue to backstop these pools and whether the secular rise of cash pools makes the system increasingly run-prone.

### Policy alternatives for dealing with institutional cash pools (Section VI)
- Four broad permanent solutions outlined:
  1. Break-up of institutional cash pools.
     - Least feasible: would require unprecedented “trust-busting” across industries and sacrifice globalization and central management efficiencies.
  2. Match Treasury bill issuance to volume and preferences of institutional cash pools.
     - Consider Treasury debt management tuned to size and duration preferences of cash pools.
     - Costs/trade-offs: (i) shift rollover risks to U.S. Treasury; (ii) shift focus away from optimizing national funding costs toward accommodating cash pool preferences; (iii) disengage a source of short-term funding from credit intermediation to the real economy.
     - Synchronizing issuance of T-bills with institutional cash pools could be a promising macroprudential tool and operationally less cumbersome than direct regulation of the shadow banking system.
     - Greenwood, Hanson and Stein (2010) argued similarly that government should tilt issuance toward short maturities if private money creation has negative externalities.
     - Note: excess reserves and large-scale asset purchases are an alternative to Treasury bills as safe, short-term, liquid assets but are less optimal for cash pools because exposures to reserves are indirect via banks.
  3. Expand lender-of-last-resort access to non-banks that issue insured deposit alternatives.
     - Broadening access to entities such as broker-dealers (repo) and maturity transformation vehicles that issued asset-backed commercial paper would involve the Fed more permanently in backstopping non-bank intermediaries.
     - Fed crisis facilities were a temporary step in this direction.
  4. Create new intermediary classes that issue deposit alternatives and bridge long-term assets to short-term cash pools.
     - New intermediaries funding in secured markets could replace runoff GSEs and shrinking agency discount note supply.
     - Without such bridges or more T-bills, expect increased issuance of products like collateralized commercial paper or putable CDs as alternatives.
- Critique of contemporaneous reform measures:
  - Current reforms have largely:
    - Pushed banks away from short-term wholesale funding toward deposit funding without considering whether deposit demand exists.
    - Adjusted deposit insurance amounts on the margin and repealed Regulation Q under the assumption cash pools’ aversion to deposits was yield-driven.
    - Mandated money funds to market floating NAV shares, without addressing how cash pools will maintain diversification away from an increasingly concentrated U.S. banking system.
  - Such reforms, absent policies that explicitly address institutional cash pools, are likely to frustrate cash pools rather than satisfy them.
- Specific policy notes:
  - Issuing more Treasury bills would absorb liquidity represented by institutional cash pools and reduce the banking system’s burden of creating collateralized, levered private alternatives.
  - If more Treasury bills had been available pre-crisis, some risky assets might have been held in real money accounts rather than levered money market accounts, potentially reducing crisis severity.
  - Broadening Fed backstop (lender-of-last-resort) to non-banks aligns with institutional cash pools’ preference to invest at a distance from banks in secured, non-M2 instruments.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2011/_wp11190.pdf*

### Section 19(i) of the Federal Reserve Act prohibiting the payment of interest on transaction

### Section 19(i) of the Federal Reserve Act prohibiting the payment of interest on transaction accounts (otherwise known as Regulation Q) effective July 21, 2011; and (iii) the increase in the deposit insurance limit on interest-bearing accounts from $100,000 to $250,000.

### Institutional cash pools: portfolio shifts and survey evidence
- Portfolio allocations of institutional cash pools to deposits roughly doubled between June 2008 and June 2011, from 16% to 33%.
- This shift was driven by:
  - the 150% increase in the FDIC’s maximum insurance amount from $100,000 to $250,000, and
  - the temporary provision of unlimited insurance on noninterest-bearing transaction accounts.
- Despite the impending repeal of Regulation Q on July 21st, 2011, further increases in allocations to deposits are unlikely:
  - According to a special question in the June 2011 survey, 45% of institutional cash pools “have no plans to increase their balances held at their U.S. relationship banks as a result of the repeal of Regulation Q or unlimited insurance on transaction accounts though of 2012.”

### Safety considerations limiting further moves into deposits
- First: Noninterest-bearing transaction accounts fully insured up through December 31st, 2012 still represent direct, unsecured exposures with uncertainty about recovery timing after a bank’s bankruptcy. Treasury bills and secured instruments such as repurchase agreements (repos) are considered safer and interest bearing alternatives, with repos offering more immediate (almost instantaneous) and certain (collateral quality dependent) recoveries than insured deposits.
- Second: For interest-bearing transaction accounts, unlimited insurance will not apply; only the new standard maximum deposit insurance amount of $250,000 applies. Given the average size of institutional cash pools and the number of FDIC-insured banks, even the higher insurance limits aren’t an efficient way for cash pools to attain safety. Treasury bills and repos will continue to represent safer alternatives.
- Third: For interest-bearing non-transaction accounts (non-overnight institutional cash balances), the $250,000 deposit insurance limits do not appear sufficient to attain full safety for institutional cash pools through insured deposits (see Appendix, Figure A14). If a shortage of short-term, government guaranteed instruments exists, future leakage of funding into the “shadow” banking system is most likely to come from this maturity spectrum.

### Demand-side drivers of the rise of the shadow banking system
- Institutional cash pools prioritize principal safety and portfolio diversification over yield and are hesitant (often for fiduciary reasons) to take on too much direct, unsecured exposures to banks through even insured deposits. Therefore, institutional cash pools are not particularly keen on being intermediated through the traditional banking system.
- Between 2003 and 2008, institutional cash pools’ cumulative demand for short-term government guaranteed instruments (as alternatives to insured deposits) exceeded the supply of such instruments by at least $1.5 trillion. The “shadow” banking system rose to fill this vacuum by creating safe, short-term and liquid instruments.
- From a demand-side perspective, the rise of “shadow” banking reflects institutional cash pools’ preference to invest cash at a distance from banks as much as it reflects banks’ funding preferences and off-balance sheet activities.
- The term “shadow banking” reflects regulatory arbitrage; from the cash pools’ perspective, the phenomenon can be viewed as market-based banking driven by portfolio diversification preferences.

### Examples and analogues: central banks and market-based solutions
- Central banks are active users of market-based banking solutions. The Bank of International Settlements (BIS) manages nearly $250 billion in cash through various cash management products for central banks globally.
- BIS products transform portfolios of long-term G7 government bonds into safe, short-term and liquid instruments that are “similar to certificates of deposit, priced at a margin below the OIS curve and liquidity enhanced by standby repurchases by the BIS”.
- Central banks keep some of their cash with the BIS to avoid concentration at banks, since as lenders of last resort to banks, it is too risky to keep all their cash at banks.

### Policy questions and implications
- Regulators should consider:
  - (i) whether to incorporate the issuance of short-term government guaranteed instruments in the macro-prudential toolkit and aim to fully meet institutional cash pools’ demand for such instruments; and
  - (ii) how, alternatively, institutional cash pools could be involved in credit intermediation to the real economy through a market-based credit system and how this system—and the insured deposit alternatives it generates as a byproduct of its credit intermediation activities—should be embraced by central banks (see Mehrling (2010)).
- Institutional cash pools’ strong safety preferences were principal drivers of the emergence of the market-based financial system. If policy frustrates the system’s ability to provide market-based safety solutions while not addressing the vacuum this creates, these factors remain fundamental sources of systemic risk and point to more frequent banking crises ahead.

### Key statistics and figures (as presented)
- Portfolio allocations to deposits: 16% (June 2008) → 33% (June 2011).
- FDIC maximum insurance amount: increased from $100,000 to $250,000 (a 150% increase).
- Survey response: 45% of institutional cash pools “have no plans to increase their balances held at their U.S. relationship banks as a result of the repeal of Regulation Q or unlimited insurance on transaction accounts though of 2012.”
- Time-bound insurance: noninterest-bearing transaction accounts fully insured up through December 31st, 2012.
- Shortfall in short-term government guaranteed instruments between 2003 and 2008: at least $1.5 trillion.
- BIS cash managed for central banks: nearly $250 billion.

*Source: _wp11190 - Section 19(i) of the Federal Reserve Act prohibiting the payment of interest on transaction accounts (otherwise known as Regulation Q) effective July 21, 2011; and (iii) the increase in the deposit insurance limit on interest-bearing accounts from $100,000 to $250,000.*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2011/_wp11190.pdf_