Institutional Cash Pools and the Triffin Dilemma of the U

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2011 International Monetary Fund WP 11 190,IMF Working Paper. Research Department, Institutional Cash Pools and the Triffin Dilemma of the U S Banking System1. Prepared by Zoltan Pozsar,Authorized for distribution by Stijn Claessens. August 2011, This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author s and do not necessarily. represent those of the IMF or IMF policy Working Papers describe research in progress by the. author s and are published to elicit comments and to further debate. 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. JEL Classification Numbers E4 G2, Keywords institutional cash pools shadow banking Treasury bills money macroprudential.
Author s E Mail Address ZPozsar imf org, I am grateful to Elena Liapkova for her encouragement to persevere and to search for the bigger picture Lena this. paper is for you The paper benefitted from discussions with James Aitken P ter Bencz r Olivier Blanchard. Stijn Claessens J lia Kir ly Matt King Michael King Richhild Moessner Perry Mehrling Grace Li. Rebecca McCaughrin Sami Mesrour Kriszti n Orb n Phil Prince Lev Ratnovski Reimo Juks Manmohan Singh. James Sweeney M rta Szeg El d Tak ts Tam s Vojnits Eric Van Wetering and seminar participants at the. Bank of Canada the Bank of England the Bank of International Settlements the U K s Independent Commission. on Banking the International Monetary Fund the National Bank of Hungary and the Sveriges Riksbank. Contents Page,I Introduction 3,II What Are Institutional Cash Pools 4. III Profiling Institutional Cash Pools 6,IV Cash Equivalents and Monetary Aggregates 11. V The Triffin Dilemma of the U S Banking System 17. VI Policy Alternatives for Dealing With Institutional Cash Pools 21. VII Conclusions 24,1 The Secular Rise of Institutional Cash Pools 6. 2 The Average Size of Institutional Cash Pools in 2007 7. 3 Institutional Cash Pools Priortized Investment Objectives 8. 4 Not Enough Banks to Source Safety for Cash Pools 8. 5 Not Enough Short Term Government Guaranteed Instruments 10. 6 Institutional Treasurers Never Put All Their Eggs in One Basket 12. 7 Broad Money and Its Components Stacked 14, 8 The Preferred Habitat of Institutional Cash Pools is in Non M2 Types of Money 15.
9 Filling the Vacuum of Short Term Government Guaranteed Debt 17. 10 Broad Money and Its Components Unstacked 19, 11 Has the Effectiveness of Deposit Insurance Been Eroded 20. Appendix Figure, 1 Non Financial Corporations Holdings of Cash and Cash Equivalents Totals 26. 2 High Net Worth Individuals 26, 3 Long Term Mutual Funds Holdings of Cash and Cash Equivalents 27. 4 Securities Lenders Holdings of Cash and Cash Equivalents 27. 5 Cash and Cash Equivalents as a Share of Total Assets 28. 6 Non Financial Corporations Holdings of Cash and Cash Equivalents Averages 28. 7 Top Holdings of Cash and Cash Equivalent 29,8 The Number of FDIC Insured Banks in the U S 29. 9 Counterparty Diversification for Cash Investing is Getting Harder and Harder 30. 10 Yield Difference Between 3 month CDs and Other Instruments 30. 11 Securities Lenders Cash Collateral Reinvestment Accounts Composition 31. 12 The Portfolio Allocation of the Rest of the World s Short Term Dollar Balances 32. 13 The Frequency of Banking Crises 32, 14 Still Not Enough Banks to Source Safety for Cash Pools 33.
References 34,I INTRODUCTION, This paper aims to answer the question 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 with the aim to better understand the systemic risks. inherent in their allocations presently, To the best of the author s knowledge this paper is the first to study the phenomenon of. institutional cash pools and to ask why wholesale funding markets have grown what the. growing presence of institutional cash pools means for financial stability and whether in the. context of the rise of institutional cash pools the effectiveness of an official safety net for. banks and deposits only has been eroding over time. The paper builds on other analyses that link the recent financial crisis to demand for safe. assets see Acharya and Schnabl 2009 Caballero 2010 and Bernanke 2011 According. to these views the financial crisis was driven by an insatiable demand from the rest of the. world for safe high quality that is AAA debt instruments which the U S financial system. produced through the securitization of lower quality ones. This paper adds two new dimensions to these views First it differentiates between demand. for long term AAA assets the focus of the above papers and short term AAA assets the. focus of the present paper, Second it expands the discussion of the demand for AAA assets from foreign central banks. demand for long term AAA assets to U S domiciled but globally active non financial. corporations and U S domiciled institutional investors demand for short term AAA assets. Throughout this paper the demand for short term AAA assets is referred to as the demand. for insured deposit alternatives see Gorton 2010 Stein 2010 and Krishnamurthy and. Vissing Jorgensen 2010 and demand for them is explained by the secular rise of. institutional cash pools, In the context of the global savings glut institutional cash pools demand for short term. AAA assets can be viewed as the flipside of foreign central banks demand for long term. AAA assets In turn cash pools demand for short term AAA assets is the principal source of. marginal demand for maturity transformation in the financial system. The paper has five conclusions 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. The paper has six remaining sections 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. Section V discusses the U S banking system s Triffin dilemma Section VI provides policy. recommendations and asks whether Basel III higher deposit insurance limits and the repeal. of Regulation Q will adequately deal with the secular rise of institutional cash pools and the. systemic risks their safety preferences engender Finally Section VII concludes with offering. an alternative non arbitrage explanation of the raison d etre of the shadow banking. system and accordingly proposes to rename it the market based financial system 2. II WHAT ARE INSTITUTIONAL CASH POOLS, The term institutional cash pool refers to large centrally managed short term cash balances. of global non financial corporations and institutional investors such as asset managers. securities lenders and pension funds see Pozsar 2011 Institutional cash pools have. become increasingly prominent since the 1990s driven by three secular developments in the. non financial corporate and institutional investor landscapes. Also see Chapter 1 of the Bank of Canada s June 2011 Financial System Review Emerging from the Shadows. Market Based Financing in Canada, First the rise of globalization and the related rise of i large global corporations and. centrally managed corporate cash pools3 and ii inequality whereby an increasingly small. core of the global population controls an increasingly large share of incomes and wealth 4. Second the rise of asset management and the related rise of i the centralized liquidity. management of mutual funds separate accounts and hedge funds within fund complexes and. ii securities lending and the related rise of cash collateral reinvestment pools. Third the rise of derivatives based investment styles such as futures based duration. positioning liability driven investing and synthetic ETFs which involve overlaying. derivatives such as futures and total return swaps onto separately managed cash pools. The common features of institutional cash pools are that they are large typically at least 1. billion in size and centrally managed The central management of cash pools refers to the. aggregation or pooling of cash balances from all subsidiaries worldwide in the case of. global corporations or all funds including mutual and hedge funds and separate accounts in. the case of asset managers Furthermore the investment decisions that pertain to pooled. balances are performed by a single decision maker typically a treasurer and through a fund. that is a single legal person but one that manages the cash balances of many legal persons. Based on time series data available on i the cash holdings of S P500 constituents ii the. holdings of liquid assets by all long term mutual funds and iii the balances in securities. lenders cash collateral reinvestment accounts the volume of institutional cash pools rose. from 100 billion in 1990 to over 2 2 trillion at their peak in 2007 the volume of. institutional cash pools stood at 1 9 trillion during the fourth quarter of 2010 5. These estimates are conservative however as due to data limitations they do not include. cash pools associated with v wealthy individuals vi endowments vii separate accounts. viii hedge funds ix derivatives based investment strategies and x insurance companies. and pension funds Industry surveys and discussions with numerous market participants. suggest that a conservative estimate of these additional types of cash pools would raise the. 2007 and 2010 totals to 3 8 and 3 4 trillion respectively see Figure 1 for additional data. see Appendix Figures A1 A4 6 Note that money funds are not included as institutional cash. pools institutional cash pools are investors in money funds but are not funds themselves. Parallel to the globalization of corporations and the pooling of their globally earned cash balances cash and. cash equivalents as a share of corporate assets have also increased in recent decades see Appendix Figure A5. and Stulz et al 1998 and Holmstr m and Tirole 2000. Since the cash balances of high net worth individuals are typically managed out of family offices the paper. considers them as institutional cash pools, The data sources used to compile these estimates include CapitalIQ ICI and RMA. The additional data sources used to compile these estimates include The Economist Credit Suisse BIS. Working Papers No 343 and discussions with numerous market participants and asset managers For the. purposes of this paper only privately owned institutional cash pools are considered Those of the foreign. official sector oil exporters and state and local governments in the U S are not. Figure 1 The Secular Rise of Institutional Cash Pools. Institutional Cash Pools and the Triffin Dilemma of the U S Banking System1 Prepared by Zoltan Pozsar Authorized for distribution by Stijn Claessens August 2011 Abstract 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

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