Federal Reserve Interdistrict Settlement.
Wolman, Alexander L.
The Interdistrict Settlement Account (ISA) is used to keep track of
movements in assets and liabilities across Federal Reserve Banks within
the Federal Reserve System. To the extent that the independent financial
status of individual Federal Reserve Banks is meaningful, the ISA is the
means by which each Bank grants credit to the other Banks in the System.
Even if one views financial independence as more apparent than real, the
behavior of individual Reserve Bank balance sheet components, including
ISA, can shed light on ongoing financial developments in the economy.
This article provides an introduction to the ISA and traces the behavior
of ISA and some other components of Reserve Bank balance sheets during
the Great Recession and the financial crisis. In addition, it provides
some speculative discussion of how Reserve Bank balance sheets could be
informative about economic conditions as the Fed exits from
unconventional monetary policy.
The ISA may seem like an obscure topic. However, in 2012 the
European debt crisis led to much discussion of the TARGET2 system, which
is--loosely--Europe's analogue to the combination of ISA and the
Fedwire funds transfer system (see Cecchetti, McCauley, and McGuire
[2012], Whelan [2012], and the references therein). Discussions about
TARGET2 often included comparisons--some of them shaky--to ISA, drawing
attention to the fact that there were few sources available describing
ISA to the lay public. (1) In attempting to help fill that void, this
article also discusses two important ways in which ISA differs from
TARGET2.
Monetary policy in the United States is implemented primarily by
the Federal Reserve Bank of New York. For example, the securities
purchases that comprise the Federal Open Market Committee's (FOMC)
large-scale asset purchase programs (LSAPs) are conducted by the New
York Fed. However, securities purchased by the New York Fed are
apportioned the same day to all 12 Federal Reserve Banks, and there is
an annual rebalancing of Federal Reserve Bank balance sheets. Both the
apportionment and rebalancing involve use of the ISA, and in recent
years these have been main drivers of the ISA. As such we provide a
relatively detailed discussion of both topics. Apportionment assures
that all 12 Federal Reserve Banks are effectively equal stakeholders in
monetary policy operations; the New York Fed simply acts as agent for
the other 11 Banks. Rebalancing, in turn, assures that over time the
securities are held by Reserve Banks in rough proportion to the
liabilities that have been issued by those Reserve Banks.
There is one authoritative source for the ISA, the Federal
Reserve's Financial Accounting Manual (FAM). While the FAM is
publicly available, it is written for users and not for the interested
public. This article is not a substitute for the FAM, but should provide
an accessible introduction to the ISA for readers without the time or
inclination to delve into the FAM. In that context, it is important to
stress that the language and terminology used here conflict at times
with the language used in the FAM. Note in particular that ISA balances
will be referred to throughout as an asset that can enter with a
positive or negative sign on Federal Reserve Bank balance sheets; this
is the same convention used in the Federal Reserve Board's 11.4.1
release, which is the source for most of the data used in the article.
1. THE INTERDISTRICT SETTLEMENT ACCOUNT: OVERVIEW AND EXAMPLES
Each of the 12 Federal Reserve Banks has its own balance sheet. The
assets on a Federal Reserve Bank's balance sheet currently consist
primarily of securities allocated to the bank by the New York Fed. The
liabilities consist mainly of Federal Reserve notes in circulation
(paper currency) and reserve accounts of banks located in the Reserve
District. Many transactions that affect a Reserve Bank's balance
sheet involve only the Reserve Bank and a commercial bank. For example,
if a commercial bank withdraws currency from the Federal Reserve Bank of
Richmond, there is an increase in the Richmond Fed's net Federal
Reserve notes outstanding, and an offsetting decrease in reserves
(denoted "other deposits held by depository institutions" on
the balance sheet as represented by the H.4.1 release); and if the
Richmond Fed makes a discount window loan to a commercial bank
(necessarily in its district), then there is an increase in the Richmond
Fed's loan assets, and an increase in its reserve liabilities.
Other transactions, however, affect the balance sheets of more than one
Federal Reserve Bank. The ISA is a line item on the asset side of each
Federal Reserve Bank's balance sheet that is used to account for
transactions across Federal Reserve Banks. It can be negative or
positive for a single Reserve Bank and always sums to zero across the 12
Reserve Banks. (2)
The ISA can be best understood through examples of different types
of transactions. Transactions that are initiated by commercial banks are
relatively easy to explain, whereas transactions that are undertaken by
the Federal Reserve Bank of New York as part of the Fed's monetary
or credit policy implementation are more complicated and will lead us
into the discussion of allocation/apportionment in the next section. For
each example, we will provide both a verbal discussion and a summary
using T-accounts.
Consider first a stylized situation where customers of a commercial
bank in the Fifth Federal Reserve District (Richmond) write checks to
customers of a commercial bank in the Sixth Federal Reserve District
(Atlanta) in the net amount of $1 million. The paying commercial bank
will see its reserve account at the Richmond Fed (an asset on the
commercial bank's balance sheet) reduced by $1 million, and it will
see its customers' deposits (a liability) reduced by $1 million.
The receiving commercial bank will see corresponding increases in its
reserve account at the Atlanta Fed and in its customers' deposits.
Just as both commercial banks have balanced changes in assets and
liabilities, so do both Federal Reserve Banks. The Richmond Fed's
reserve account liabilities decrease by $1 million, the Atlanta
Fed's reserve account liabilities increase by $1 million, and the
offsetting changes on the asset side of the Reserve Banks' balance
sheets occur through the ISA. Because the Richmond Fed is effectively
making a payment to the Atlanta Fed, its ISA balance (an asset) falls by
$1 million, and the Atlanta Fed's ISA balance rises by $1 million.
Tables 1 and 2 show the relevant T-accounts. If ISA did not exist, there
are two possibilities for how to account for this transaction (ignoring
legal issues). One possibility is that securities or other assets could
be transferred from the Richmond Fed to the Atlanta Fed. (3)
Alternatively, the balance sheets of the Federal Reserve Banks could be
consolidated, so that the transaction would simply involve a relabeling
of accounts with the single Federal Reserve Bank. We will not go through
these alternatives for the other examples below, but the reader should
keep in mind that similar reasoning applies.
Table 1 T-Accounts for Commercial Banks, Check Clearing Example
Paying Commercial Bank ("Bank A")
Assets Liabilities
-$1 million, Reserve account (at -$1 million, customer deposits
Richmond Fed)
Receiving Commercial Bank ("Bank B")
Assets Liabilities
+$1 million, Reserve account (at +$1 million, customer deposits
Atlanta Fed)
Table 2 T-Accounts for Federal Reserve Banks, Check Clearing Example
Paying Federal Reserve Bank (Richmond)
Assets Liabilities
-$1 million, ISA balances -$1 million, Bank A reserve account
Receiving Federal Reserve Bank (Atlanta)
Assets Liabilities
+$1 million, ISA balances +$1 million, Bank B reserve account
Next, consider delivery of $1 million of new currency (bills) to
the Federal Reserve Bank of New York (for example), where the new
currency is designated as issued by the Federal Reserve Bank of San
Francisco. (4) In this case, the Federal Reserve Bank of San
Francisco's liabilities increase by $1 million ("Federal
Reserve notes outstanding" on the 11.4.1 release) and the Federal
Reserve Bank of New York's liabilities decrease by $1 million
("Notes held by Federal Reserve Banks" on the H.4.1). (5) Of
course, both Banks must have an offsetting balance sheet change, and
these involve the ISA: The San Francisco Fed's ISA balance
increases by $1 million, and the New York Fed's ISA balance
decreases by $1 million. The T-accounts are trivial in this case, shown
in Table 3. In effect, the New York Fed is purchasing currency from the
San Francisco Fed using its ISA account.
Table 3 T-Accounts for Federal Reserve Banks, New Currency Example
Federal Reserve Bank of San Francisco
Assets Liabilities
+$1 million, ISA balances +$1 million, Federal Reserve Notes
outstanding
Federal Reserve Bank of New York
Assets Liabilities
-$1 million, ISA balances -$1 million, Notes held by Federal
Reserve Banks
We move now to transactions related to the implementation of
monetary or credit policy. These transactions are typically initiated by
the Federal Reserve Bank of New York, and thus at first only impact the
New York Fed's balance sheet. (6) However, according to the
policies set forth in the FAM, the associated balance sheet changes are
apportioned on a daily basis to all 12 Federal Reserve Banks.
Consider first a typical asset purchase that affects the domestic
portfolio of the System Open Market Account (SOMA). The Fed's
ongoing large-scale asset purchases fall into this category, so we will
use a specific example of one of these purchases. On December 27, 2012,
the Federal Reserve Bank of New York purchased $4.614 billion of
Treasury securities from the primary dealers who serve as trading
counterparties with the New York Fed. (7) These purchases settled on
December 28, which means that on December 28 the Federal Reserve Bank of
New York's securities holdings (an asset) increased by $4.614
billion. The primary dealers were paid for these securities by credits
to their accounts in reserve-holding banks; thus, the New York
Fed's reserve liabilities increased by $4.614 billion. (8)
Subsequently, but still on December 28, the $4.614 billion increase in
securities holdings was apportioned to all 12 Federal Reserve Banks
according to the percentages listed in the second column of Table 4. How
those percentages are determined will be discussed in detail in the next
section; the procedure is complicated, but loosely it tends to assign
higher percentages to Reserve Banks with a higher percentage of currency
outstanding and deposit liabilities. The reduction in the New York
Fed's securities holdings and the increases in the other Reserve
Banks' securities holdings were offset by increases in New
York's ISA balance and decreases in the other Banks' ISA
balances. Again, it is as if the other 11 Federal Reserve Banks
purchased securities from the New York Fed using their ISA accounts.
Table 5 puts this example in T-account form, for the New York Fed and
the Richmond Fed. New York has two steps; in the first step it receives
all the securities, and in the second step it apportions 43.935 percent
of the securities to the other 11 Banks. In the apportionment step,
7.117 percent of the securities are apportioned to Richmond.
Table 4 SOMA Portfolio Allocation Percentages
Domestic Foreign
District 2012 2011 2012 2011
Boston 2.429 2.459 3.506 3.456
New York 56.065 46.504 32.258 28.963
Philadelphia 3.306 3.426 8.674 9.686
Cleveland 2.542 2.701 7.393 7.418
Richmond 7.117 11.549 20.685 20.505
Atlanta 6.029 7.434 5.718 5.731
Chicago 5.548 5.939 2.668 2.534
St. Louis 1.563 1.893 0.818 0.815
Minneapolis 0.909 1.537 0.408 3.089
Kansas City 2.009 2.660 0.995 0.900
Dallas 3.885 3.955 1.602 1.515
San Francisco 8.596 9.944 15.277 15.388
System Total 100 100 100 100
Table 5 T-Accounts for Federal Reserve Banks, Asset Purchase Example
Federal Reserve Bank of New York
Assets Liabilities
Step +$4.614 billion +$4,614 billion commercial bank
1 securities deposits (reserves)
Step -$2.027 billion --
2 securities
Step +$2.027 ISA balances --
3
Federal Reserve Bank of Richmond
Assets Liabilities
+$328 million securities --
-$328 million ISA --
balances
A similar process occurs for foreign-currency denominated assets in
the SOMA portfolio, but the apportionment uses percentages based on
member bank capital in each district. Apportionment will be discussed in
more detail below. An example of a foreign-currency denominated
transaction occurred the week of August 15, 2012, when the European
Central Bank (ECB) drew on its swap line with the Federal Reserve Bank
of New York by $7 billion; the swap line allows the ECB to lend dollars
to European banks, creating dollar reserves in the process. (9) The New
York Fed's assets increased by $7 billion, in the form of holdings
of Euros in an account at the ECB; its liabilities also increased by $7
billion, in the form of increased deposits, corresponding to deposits in
U.S. commercial banks held by the European banks that borrowed dollars
from the ECB. The same day that the swap drawdown occurred, the $7
billion increase in foreign currency holdings was apportioned to all 12
Federal Reserve Banks according to the percentages listed in the fourth
column of Table 4. The reduction in the New York Fed's foreign
currency holdings and the increases in the other Reserve Banks'
foreign currency holdings were balanced by increases in New York's
ISA balance and decreases in the other Banks' ISA balances. Again,
this example is summarized in T-account form for New York and Richmond,
in Table 6.
Table 6 T-Accounts for Federal Reserve Banks, Foreign Currency
Swap Example
Federal Reserve Bank of New York
Assets Liabilities
Step +$7 billion +$7 billion commercial bank deposits
1 Euros at ECB (reserves)
Step -$4.742 billion --
2 Euros at ECB
Step +$4.742 billion --
3 ISA balances
Federal Reserve Bank of Richmond
Assets Liabilities
+$1.448 billion --
Euros at ECB
-$1.448 billion --
ISA balances
2. ALLOCATION OF SOMA TRANSACTIONS AND ANNUAL REBALANCING
Table 4 listed the percentages according to which foreign and
domestic SOMA transactions were allocated to the 12 Reserve Banks in
2011 and 2012. These percentages are updated annually through a process
that reflects ISA balances over the year and the composition across
Districts of currency outstanding (for the domestic portfolio) and the
composition across Districts of member bank capital (for the foreign
portfolio). New York has by far the highest allocation percentage for
both the foreign and domestic portfolios, but the percentages for the
other 11 Banks varied widely in 2012, from a low of 0.41 percent of the
foreign portfolio for the Minneapolis Fed, to a high of 20.69 percent of
the foreign portfolio for the Richmond Fed. The remainder of this
section describes how the percentages are determined. An important
element of the domestic portfolio rebalancing is that it also involves
an approximate "settling" of ISA balances. In contrast, the
foreign portfolio rebalancing generates ISA transactions as an outcome,
but they do not drive the process.
Domestic Portfolio
In April of each year, the 12 Reserve Banks' allocation
percentages for the domestic SOMA portfolio are updated. We will use a
hypothetical example for the Federal Reserve Bank of Richmond to explain
how the process works. Before going into the details, we need to
introduce the gold certificate account, an item on the asset side of
each Federal Reserve Bank's balance sheet. The gold certificate
account is a carryover from the time that the United States was on a
gold standard. Today, the Systemwide gold certificate account
corresponds to the value of gold held by the U.S. Treasury. While the
gold certificate account plays a role in the process described below, in
no way do the Treasury's gold holdings restrict the quantity of
currency or bank reserves that the Federal Reserve can issue.
1. Denote Richmond's average daily ISA balance for the
preceding 12 months by B, and recall that we follow the 11.4.1 release
and put ISA on the asset side of the balance sheet. In the first step,
the ISA balance is reduced by B, and there is an offsetting increase of
B in the Richmond Bank's gold certificate account. If B is
negative, then the ISA balance rises and the gold certificate account
falls in this step. (10)
2. Denote the Systemwide ratio of the gold certificate account to
the value of Federal Reserve notes by [bar.p]. (11) Denote the
corresponding ratio for the Richmond Bank by [p.sub.R]. In the second
step, Richmond's gold certificate account is adjusted upward or
downward--as appropriate--to equate the new [p.sub.R] to [bar.p]. The
offsetting balance sheet entry is a decrease or increase in
Richmond's holdings of the domestic SOMA portfolio.
3. Denote the new ratio of Richmond's domestic SOMA portfolio
holdings to the total domestic SOMA portfolio by [delta]. Until the
following April, Richmond's allocation of the domestic SOMA
portfolio will be given by [delta].
The rebalancing process is undeniably complicated. However, some
intuition can be gained by thinking about a hypothetical case where the
allocation of securities purchases is always quickly accompanied by
matching reserve flows. Each time the New York Fed purchases securities,
an identical quantity of reserve liabilities is created, typically on
the balance sheet of the New York Fed. A fraction of the securities are
quickly allocated to the Richmond Fed. If reserves of the same magnitude
then flow from the New York Fed to the Richmond Fed, there will be
offsetting ISA transactions. If this occurs for every securities
purchase, then in step 1 above there will be zero average ISA balance,
and the only adjustment in April would occur because of different growth
in Richmond Federal Reserve notes than in the System as a whole. This
example makes clear that it is primarily the combination of differential
growth in reserves and currency that leads to changes in a Reserve
Bank's allocation percentage for the domestic portfolio.
To further illustrate the relationship between a Reserve
Bank's share of liabilities and its allocation percentage, Table 7
lists each Bank's share of total reserves ("other
deposits") and net Federal Reserve notes outstanding on April 10,
2013, together with the 2012 SOMA domestic allocation percentages from
Table 4. For every Reserve Bank except San Francisco, the SOMA
percentage lies between the Reserve Bank's share of currency and
its share of reserves. As we have seen, in any given year the allocation
is a complicated function of past history, ISA over the prior 12 months,
and the distribution of Federal Reserve notes. However, the table shows
that the distribution of currency (Federal Reserve notes) and reserves
together are generally a good approximation to the SOMA allocation.
Table 7 Currency and Reserves by District (April 10, 2013),
and SOMA Domestic Allocations for 2012
District Currency (%) Reserves (%) SOMA (%)
Boston 3.33 1.64 2.43
New York 37.70 67.07 56.07
Philadelphia 3.31 2.01 3.31
Cleveland 4.34 1.10 2.54
Richmond 7.30 4.85 7.12
Atlanta 12.37 2.96 6.03
Chicago 6.75 3.72 5.55
St. Louis 2.61 0.79 1.56
Minneapolis 1.67 0.53 0.91
Kansas City 2.66 1.26 2.01
Dallas 6.96 2.71 3.89
San Francisco 11.01 11.35 8.60
System Total 100 100 100
Finally, an important thing to note about the annual rebalancing
process is that it generally does not result in a Reserve Bank's
ISA balance moving to zero. This would only happen if the Reserve
Bank's ISA balance on the day of rebalancing were equal to its
average balance over the prior 12 months.
Foreign Portfolio
The annual foreign portfolio allocation percentages are determined
in January, rather than April. As with the domestic portfolio, a onetime
adjustment takes place to bring the account balances across Reserve
Banks in line with the new percentages. However, whereas the domestic
allocations are determined by a complicated process involving prior-year
ISA balances and the distribution of Federal Reserve notes, the foreign
allocations derive in a simple way from the distribution of Reserve Bank
capital. Each Reserve Bank has capital and surplus, based on the capital
of the member banks in the respective Federal Reserve District (see
Section 5 of the Federal Reserve Act for the details). Again, we will
use a hypothetical example for the Federal Reserve Bank of Richmond to
explain the annual process for determining the new foreign allocation
and for reconciling the foreign portfolio.
Denote the Richmond Fed's share of the SOMA foreign portfolio
by [[empty set].sub.0]. Denote the Richmond Fed's share of
Systemwide capital and surplus by k. For the next year, changes to the
SOMA foreign portfolio will be allocated to the Richmond Fed according
to the ratio k. There is also a one-time rebalancing, to equate
Richmond's foreign portfolio share to its capital share. If the
capital share is greater than the foreign portfolio share (k >
[[empty set].sub.0]), then the foreign portfolio is increased to make
the new share, call it [[empty set].sub.1]. equal to k. And if k <
[[empty set].sub.0], then Richmond's foreign portfolio balance is
decreased so that [[empty set].sub.1] = k. In the former case, the
increase in Richmond's foreign portfolio balance is offset by a
decrease in Richmond's ISA balance. Likewise, if k < [[empty
set].sub.0], there is an offsetting increase in Richmond's ISA
balance. Effectively, Richmond is buying (or selling) shares in the SOMA
foreign portfolio using its ISA balances.
Referring to columns 4 and 5 of Table 4, the differential
allocation percentages among Reserve Banks for the foreign portfolio
simply reflect different levels of capital of the member banks in each
district. The Richmond Fed has a relatively large allocation percentage
for the foreign portfolio because Bank of America, one of the four
largest banks in the country, is a member bank located in the Richmond
District.
If one is tracking Reserve Bank ISA balances, the annual
adjustments in January and April are significant for two reasons. First,
to the extent that there were persistently large ISA balances over the
prior year, say because of significant changes in the size of the
domestic SOMA portfolio, the April rebalancing would lead to large
one-time ISA flows. (12) Second, to the extent there are significant
changes in the size of the overall SOMA portfolio over the corning year,
say because of asset purchases or sales, or swap line drawdowns, the new
percentages will affect the ISA flows as the portfolio grows or shrinks.
Comparison to TARGET2
The European Monetary Union has a similar character to the United
States from a monetary perspective, in that it is composed of a system
of central banks that together administer a single currency. Just as the
ISA provides, and measures, a form of credit among Federal Reserve
Banks, the TARGET2 system in Europe provides, and measures, a form of
credit among the national central banks in Europe. (13) Because there is
a wealth of literature describing how TARGET2 works in the Eurosystem,
we will not go into any detail on that topic here, instead focusing on
two important differences between TARGET2 and the ISA. One difference
involves how the systems work, and it has received significant attention
already. (14) The other difference involves the interpretation of
TARGET2 versus ISA balances, which has received less attention.
A key operational difference between TARGET2 and the ISA involves
rebalancing. In the Eurosystem, there is no regular administrative
process corresponding to the Federal Reserve System's April ISA
rebalancing. In principle then, it is possible for TARGET2 balances
among countries in the European Monetary Union to grow arbitrarily large
in absolute value. In practice, the European sovereign debt crisis was
associated with persistently large positive TARGET2 balances for
Germany, Netherlands, Luxembourg, and Finland, and persistently large
negative TARGET2 balances for Ireland, Portugal, Greece, Spain, and
Italy. However, since late 2012, the absolute level of TARGET2 balances
has been declining in most of these countries. (15)
As we will see below, the ongoing increase in the Federal Reserve
System's balance sheet, together with the limited tendency for
reserve balances to flow from New York to the other Districts, means
that without the annual rebalancing, New York--like the first group of
European countries listed above--would have a persistently increasing
ISA balance. Would such a scenario create the same uproar in the United
States that it has created in Europe? Likely not, because (i) Federal
Reserve Districts do not correspond to national, or even state borders,
and (ii) the (hypothetical) accumulation of ISA balances in New York is
associated with the fact that New York is a financial center, rather
than with an especially strong economy in the New York Federal Reserve
District. In fact, as Eichengreen, Mehl, and Chitu (2013) discuss, prior
to 1975 annual rebalancing did not take place among Federal Reserve
Banks. In principle, there was instead daily settlement across regional
banks using gold certificates, but in practice "interclistrict
accommodation operations" took place and balances did build up over
time. Eichengreen, Mehl, and Chitu (2013, 4) argue that the build up of
these balances "did not excite experts or the American public, nor
in most cases did they trigger insurmountable tensions between
regions." (16)
The second important difference between ISA and TARGET2 arises from
the different degrees of financial integration within Europe and the
United States. One element--albeit a relatively recent one--of the
highly integrated U.S. financial system is the prominent role of
interstate bank branching. Interstate bank branching and its corollary
interdistrict bank branching mean that some bank deposits are located in
a Federal Reserve District that is different than the one where the
reserves backing that deposit are held. Because the location of reserves
may not coincide with the residence of depositors, ISA flows may give
misleading information about underlying financial flows.
Consider again the check clearing example from Table 1. Suppose
JPMorgan Chase customers in Ohio write checks for $1 million to Bank of
America customers in California. These transactions represent a transfer
of bank deposits from residents of the Cleveland Federal Reserve
District to residents of the San Francisco Federal Reserve District.
However, JPMorgan Chase's reserve account is held with the Federal
Reserve Bank of New York, and Bank of America's reserve account is
held with the Federal Reserve Bank of Richmond. Based on ISA balances
then, one would incorrectly interpret the transactions as representing a
transfer of liquid assets from the New York District to the Richmond
District.
In practice, the fraction of deposits with the property just
described is quite large. For example, on June 30, 2013, JPMorgan Chase
had customer deposits of $950 billion, but less than half of those
deposits were held at branches within the New York Federal Reserve
District. Or consider Bank of America, with customer deposits of $1.02
trillion, more than 45 percent of which were held in just four states
outside the Richmond district: California ($241 billion), Florida ($81
billion), New York ($62 billion) and Texas ($82 billion). (17) These
examples are much less prevalent in Europe: For the most part, transfers
of deposits from a bank in Germany to a bank in Finland, for example,
would represent transfers of deposits from German residents to Finnish
residents.
3. INTERDISTRICT FLOWS DURING AND AFTER THE GREAT RECESSION
We turn now to actual data on ISA and other aspects of Reserve Bank
balance sheets, concentrating on the post-2007 period. ISA behavior
underwent a marked change after 2007 as a result of the Fed's
credit programs, asset purchases, and swap lines with foreign central
banks. After describing some of the more notable aspects of that
behavior, we then suggest one way in which ISA behavior could provide
useful information about the state of the economy as the Fed begins its
exit from unconventional monetary policy.
Unconventional Monetary Policy and the ISA
Prior to September 2008, the balance sheets of the 12 Federal
Reserve Banks grew at a fairly steady rate, mainly reflecting growth in
currency demand as the economy grew. Secular growth does not necessarily
in ply changes in ISA balances, and both the volatility and absolute
level of Reserve Bank ISA balances were low over this period. During the
autumn of 2008, the Federal Reserve began paying interest on reserves at
near market rates and lowered its Fed Funds rate target to near zero.
Either one of these actions on its own would have severely reduced
banks' incentive to economize on reserve holdings--previously a
small fraction of currency outstanding. Simultaneously, and in a process
that continues today, the Fed embarked on a series of credit expansion
and asset purchase programs that dramatically increased the quantity of
bank reserves: As of December 25, 2013, the aggregate level of reserves
stood at $2.5 trillion, more than 239 times the level in early September
2008. (18) As described in Section 1, the asset purchases and central
bank liquidity swaps that have generated much of this increase
necessarily involve ISA transactions because the initial balance sheet
increase at the New York Fed is subsequently allocated to the other 11
Banks. Thus, ISA balances at the 12 Reserve Banks behaved very
differently after September 2008 than they had previously. In the
remainder of this section we discuss ISA behavior in the post-September
2008 period, concentrating on the Richmond and New York Banks.
Figure 1 displays four of the main components of the consolidated
12 Federal Reserve Bank balance sheets. Currency and reserves, which are
liabilities to the Fed (hence denoted by an "L" in the
legend), are plotted as the dashed orange and black lines, and the asset
categories securities and swaps (hence "A" in the legend) are
plotted as the solid blue and red lines. The figure reflects the
discussion in the previous paragraph: In "normal times"
securities grew steadily, hand in hand with currency. Once the large
balance sheet expansions began in 2008, the dramatic increases in swaps
and then securities were reflected in the growth of reserves, with
currency remaining on a relatively stable upward trend.
[FIGURE 1 OMITTED]
For the same time period, Figure 2 plots ISA balances for the New
York and Richmond Federal Reserve Banks, as well as the mean absolute
value of ISA balances across all 12 Reserve Banks. There are several
notable features of this figure. As stated above, before 2008, when
currency and securities were growing steadily and reserves were low,
both the level and volatility of ISA balances were low relative to their
later behavior; this applies to Richmond, New York, and the entire
System as reflected in the mean absolute value. That said, the swings in
New York's ISA balance were large relative to the other Banks
(compare the black line in Figure 2 to the red solid and blue dashed
lines).
[FIGURE 2 OMITTED]
In a typical year before 2008, the New York Fed would be purchasing
securities at a steady rate, and then immediately "selling" a
significant fraction of those securities to the other 11 Banks, in
exchange for ISA balances. This would tend to make New York's ISA
balance increase over the course of the year ending in April, when the
annual rebalancing of the domestic SOMA portfolio occurs. However, a
close look at Figure 2 reveals that New York's ISA balance was just
as likely to be decreasing over the year to April. The explanation may
lie in the behavior of reserve balances: When the New York Fed purchases
securities, the initial increase in reserves generally occurs in the
accounts of banks in the New York District because the securities are
sold by primary dealers, whose commercial bank accounts tend to be with
New York banks. Over time, however (prior to 2008), the newly created
reserves would spread out across the System, roughly in proportion to
economic activity, and be converted to currency. If the spreading out
occurred before the conversion to currency, then it would involve an
increase in ISA balances for other Banks and a decrease for New York, to
offset New York's lower reserve account liabilities and other
Banks' higher reserve account liabilities. Overall, ISA balances
were low and stable at the other 11 Banks because, to a first
approximation, the other 11 Banks were simply offsetting New York's
fluctuations, with percentages similar to those in Table 4 (recall that
the percentages are updated annually).
Beginning in September 2008, just as the size and composition of
the consolidated Federal Reserve Banks' balance sheet began to
change dramatically, so did the behavior of ISA balances. This occurred
at the New York Fed as well as the other Reserve Banks. From the end of
1999 through September 10, 2008, the New York Fed's average
absolute ISA balance was $17.1 billion; from September 17, 2008, through
the end of 2013, New York's absolute ISA balance averaged $141.2
billion. For all Federal Reserve Banks, the corresponding increase was
from $4.5 billion to $35.2 billion. (190
While the entire post-2008 period has been characterized by high
and volatile ISA balances, the behavior of New York and Richmond's
ISA balances relative to the rest of the System divides into five
distinct phases. In phase 1, from September 2008 through March 2009, New
York's ISA balance rose and fell dramatically, and Richmond moved
in opposite directions with somewhat smaller swings. Phase 1 is mainly
accounted for by the behavior of swap lines. Swap line drawdowns
increased from $62 billion on September 17, 2008, to their peak of $583
billion on December 10, and then by March 11, 2009, had fallen to $314
billion. As swap drawdowns rose and fell, New York's ISA balance
would naturally rise and fall (Richmond's would fall and rise). In
phase 2, roughly from March through the end of 2009, both New York and
Richmond's ISA balances were increasing. For New York, this was due
to the first round of LSAPs, and for Richmond it seems to have been due
to an increase in deposits (reserves) that was quite large relative to
other Banks (see Figure 4). Both Richmond and New York's ISA
balances were relatively stable throughout 2010, apart from a large
decrease for Richmond with the annual rebalancing of the domestic SOMA
portfolio in April; because of Richmond's large average balance
over the previous 12 months, the 2010 rebalancing involved reducing
Richmond's ISA balance by approximately $175 billion. (20)
[FIGURE 4 OMITTED]
During phase 3, which lasted from late 2010 through the April 2012
domestic SOMA rebalancing, ISA balances in Richmond and New York were
driven by the increase in reserves from the second LSAP program. The
typical pattern associated with securities purchases occurred: New
York's ISA balance increased as it allocated the newly pm-chased
securities across the System, and Richmond's ISA balance decreased
as it "purchased" securities from New York. These asset
purchases ended in the middle of 2011, and ISA balances were relatively
stable until the April 2012 rebalancing. At that time there was a large
reallocation of securities from Richmond to New York, with a
corresponding decrease in New York's ISA balance and an increase in
Richmond's ISA balance; effectively, New York was purchasing back a
similar but not identical quantity of seem-hies from Richmond.
Regarding phase 3, there has been some speculation among
commentators that rebalancing did not occur in April 2011. As evidence
in favor of this view, Koning (2012) notes that while the New York Fed
had an average ISA balance of around $147 billion over the previous 12
months, there is no evidence in the 11.4.1 data of a similar-sized ISA
decrease in April 2011. However, Koning also notes that the discrepancy
may be a result of the inherent limitations in weekly data. In fact,
this latter view is correct. Rebalancing did occur as usual, as can be
confirmed by looking at the behavior of securities on the New York
Fed's balance sheet.
Figure 3 zooms in on the behavior of the New York Fed's ISA
and securities holdings, from April 2010 through June 2011. The three
vertical lines in the figure represent April 6, April 13, and April 20,
2011. As described in Section 2, the annual domestic portfolio
rebalancing for a Bank with positive ISA balance over the past year
involves a decrease in its ISA balance and an equal-sized increase in
its securities holding; the Bank is effectively purchasing securities
with its ISA balance. Although New York's ISA did not display an
unusual decrease in April 2011, its securities holdings did increase by
$150 billion from April 13 to April 20. Securities were increasing
steadily during that period because of the second LSAP program, but the
rate of increase was nowhere close to $150 billion per week. The only
plausible explanation for the $150 billion increase in securities is the
annual rebalancing, which Koning indeed calculates ought to have been
close to $150 billion. The ISA change is not visible in the weekly data
because it was partially offset by other factors unrelated to the
rebalancing.
[FIGURE 3 OMITTED]
Phase 4, from April 2012 until late 2012, was characterized by
declining ISA balances in both Richmond and New York. During this
period, aggregate reserves were relatively stable (Figure 4), but
deposit liabilities in both Richmond and New York were declining, with
the offset coming from ISA balances. Evidently reserves were flowing out
of Richmond and New York to the other Districts. Finally, phase 5
corresponds to the ongoing third LSAP program. New York's ISA
balance has increased markedly from allocating the new securities
purchases, and Richmond's balance has generally been declining
since the last SOMA rebalancing in April 2013.
ISA Fluctuations as a Potential Signal for Monetary Policy
In comparing TARGET2 to ISA, we noted that the prevalence of
in-terdistrict branching in the United States meant that ISA behavior
was unable to provide the kind of information about cross-region payment
flows that TARGET2 can provide. However, it should be clear from the
example we used to make that point that ISA behavior does provide some
information about payment flows across institutions. At the weekly
level, only net flows across Federal Reserve Districts are captured, so
flows across institutions within the same Federal Reserve District are
missed entirely. Nonetheless, there may be some value in the information
that is captured by ISA.
Starting in December 2013, the Federal Reserve began to reduce the
pace of securities purchases in its third LSAP program. Assuming that
the economic recovery continues, the tapering of asset purchases is
likely to be the first stage in an exit from unconventional monetary
policy, where the later stages will involve an increase in the federal
funds rate target and a reduction in the Federal Reserve's
securities holdings. Ennis and Wolman (2010, 2012) have argued that the
large quantity of reserves outstanding makes it especially important
that the Fed not fall behind the curve in raising its target for the
federal funds rate. The financial flows represented by ISA fluctuations
may provide one useful signal about the right time to raise that target.
Informally, the idea is that if monetary policy were to fall behind
the curve we would eventually expect to see inflation, but the inflation
would likely be preceded by more rapid turnover of the monetary base (in
particular, bank reserves). That increase in turnover would in turn be
reflected in an increase in volatility of ISA balances. Figure 5 plots
one measure of this volatility, from 2008 through 2013. For each Reserve
Bank, we calculated the absolute valuable of the weekly change in the
Bank's ISA balance, from the H.4.1 report. Then, for each week, we
calculated the standard deviation of these changes across the 12 Banks.
The jagged line in Figure 5 is the time series for this standard
deviation, and the grey horizontal line is the mean over the period from
January 2008 through December 2013. There are no surprises in Figure 5,
given what we already know from the previous figures. In September 2009
there was a discrete upward shift in the dispersion measure, but since
that time the series' behavior has been relatively steady, apart
from spikes at the April rebalancing in 2010 and 2012. In the scenario
where ISA behavior signals that it may be time for interest rates to
rise, we would see an upward shift in the dispersion measure.
[FIGURE 5 OMITTED]
Anyone can track the dispersion measure in Figure 5, simply by
downloading data from the Federal Reserve's website. As such, it
may provide a useful way for the interested public to track monetary
conditions. Policymakers themselves have access to the daily reserve
balances of every financial institution with an account at a Federal
Reserve Bank. They can therefore construct a more granular version of
Figure 5, which begins with the absolute daily change in reserve
balances for each account-holding institution, instead of the absolute
weekly change in ISA balances for each Reserve Bank.
4. CONCLUSION
The massive expansion of the Federal Reserve System's balance
sheet since 2008 has been accompanied by a notable increase in payment
flows across Federal Reserve Districts. These payment flows are measured
by the Federal Reserve's Interdistrict Settlement Account (ISA),
much as fluctuations in TARGET2 balances measure payment flows across
national central banks within the Eurosystem. There is, however, an
important difference in the mechanics of the two systems; annual
rebalancing occurs in the United States but not in Europe. In addition,
because the U.S. banking system is highly integrated across regions,
there are limits to the kind of information about payment flows that can
be conveyed by ISA data.
Although the post-crisis period comprises several distinct phases
of ISA behavior, as described in Section 3, the overall trend has been
one in which the FOMC's asset purchase programs have tended to
increase ISA balances (an asset) as well as deposit liabilities on the
New York Fed's balance sheet. Absent the annual rebalancing
process, described in Section 2, rough calculations suggest that New
York's ISA balance would have risen to approximately $800 billion
by the end of 2013, assuming that it started at zero at the beginning of
1999. Going forward however, as the asset purchase programs are
eventually reversed, we should expect the behavior of ISA balances at
New York and the other Banks to reverse as well. As long as the quantity
of bank reserves remains large, the behavior of ISA balances may turn
out to be a useful indicator of when the time has come for the fed funds
target to rise.
What follows is a more formal statement of the process described in
Section 2, for annual settlement of ISA using the domestic SOMA
portfolio.
1. (a) Denote Richmond's average ISA balance for the preceding
12 months by [B.sub.R], and recall that we follow 11.4.1 and put ISA on
the asset side. In the first step, the ISA balance is reduced by
[B.sub.R], and there is an offsetting increase of [B.sub.R] in the
Richmond Bank's asset item, "gold certificate account."
If [B.sbu.R] is negative, then the ISA balance rises and the gold
certificate account falls in this step.
(b) Denote the Systemwide ratio of the gold certificate account to
the value of Federal Reserve notes by [bar.p]. Denote the corresponding
ratio for the Richmond Bank by [p.sub.R]. In the second step,
Richmond's gold certificate account is adjusted upward or
downward--as appropriate--to equate the new [p.sub.R] to [bar.p]. The
offsetting balance sheet entry is a decrease or increase in
Richmond's holdings of the domestic SOMA portfolio.
(c) Denote the new ratio of Richmond's domestic SOMA portfolio
holdings to the total domestic SOMA portfolio by [delta]. Until the
following April, Richmond's allocation of the domestic SOMA
portfolio will be given by [delta].
(d) Given
[I.sub.R,0] = Richmond's initial ISA balance
[B.sub.R] = Richmond's average ISA balance
[I.sub.R,1]= Richmond's new ISA balance
[G.sub.R,0] = Richmond's initial gold certificate account
[G.sub.R,1] = Richmond's "intermediate" gold
certificate account
[G.sub.R,2] = Richmond's new gold certificate account
G = System's gold certificate account
N = System's Federal Reserve notes
[N.sub.R] = Richmond's Federal Reserve notes outstanding
[S.sub.R,0] = Richmond's initial SOMA holdings
[S.sub.R,1] = Richmond's new SOMA holdings
S = System's SOMA holdings
[[delta].sbu.R] = Richmond's new SOMA allocation percentage
i. In step a, we have [I.sub.R,1] = [I.sub.R,0] and [G.sub.R,1] =
[G.sub.R,O] + [B.sbu.R].
ii. In step b, we have [G.sbu.R,2] = [G.sub.R,1] + (G/R[N.sub.R] -
[G.sub.R,1]) and [S.sbu.R,1] = [S.sub.R,0] - ([G.sub.R,2] -
[G.sbu.R,1]).
iii. Thus, for step c, [[delta].sub.R] = [S.sub.R,1]/S.
iv. Note that [G.sbu.R,1] is completely artificial. For an instant,
a bank's gold certificate account could go highly negative or could
go higher than the System's total, though at every instance the
total across Banks does sum to the System's total. We can rewrite
the process without [G.sub.R,1] as [G.sub.R,2] = G/N[N.sub.R] and
[S.sub.R,1]] = [S.sub.R,0] - (G/N[N.sub.R] - ([G.sub,R,0] + [B.sub.R]))
This makes it clear that Richmond's gold certificate account only
changes to the extent that either (i) the System's ratio of gold
certificate account to notes changes, or (ii) Richmond's notes
quantity changes. And, Richmond's SOMA changes if (i)
Richmond's gold certificate account changes, or (ii), more
importantly in practice, if Richmond's ISA balance averaged
something other than zero over the previous 12 months.
The author is grateful to Ceei Adams for her patient explanations
of ISA accounting, and to Huberto Ennis, Peter Gather, Bob Hetzel, J.P.
Koning, Marisa Reed, Karl Rhodes, and John Weinberg for comments and
discussions. The views in this article are the author's. They do
riot represent the views of the Federal Reserve Bank of Richmond or the
Federal Reserve System. E-mail:
[email protected].
APPENDIX: FORMAL DESCRIPTION OF ISA SETTLEMENT
REFERENCES
Board of Governors of the Federal Reserve System. 2014.
"Factors Affecting Reserve Balances. Federal Reserve Statistical
Release 11.4.1." Available at www.federalreserve.gov/releases/h41/.
Board of Governors of the Federal Reserve System. 2014. Financial
Accounting Manual for Federal Reserve Banks. Available at
www.federalreserve.gov/monetarypolicy/files/BSTfinaccountingmanual.pdf.
Cecchetti, Stephen G., Robert N. McCauley, and Patrick M. McGuire.
2012. "Interpreting TARGET2 balances." BIS Working Papers No.
393. Available at www.bis.org/publ/work393.pdf.
Eichengreen, Barry, Arnaud Mehl, and Livia Chitu. 2013.
"Mutual Assistance between Federal Reserve Banks, 1913-1960 as
Prolegomena to the TARGET2 Debate." Manuscript.
Ennis, Huberto M., and Alexander L. Wolman. 2010. "Excess
Reserves and the New Challenges for Monetary Policy." Federal
Reserve Bank of Richmond Economic Brief 10-03.
Ennis, Huberto M., and Alexander L. Wolman. 2012. "Large
Excess Reserves in the U.S.: A View from the Cross-Section of
Banks." Federal Reserve Bank of Richmond Working Paper No. 12-05.
Keister, Todd, and James McAndrews. 2009. "Why Are Banks
Holding So Many Excess Reserves?" Federal Reserve Bank of New York
Current Issues in Economics and Finance 15 (December).
Koning, J.P. 2012. "The Idiot's Guide to the Federal
Reserve Interdistrict Settlement Account." Available at
http://jpkoning.blogspot.ca/2012/02/idiots-guide-to-federal-reserve.html.
Lubik, Thomas A., and Karl Rhodes. 2012. "TARGET2: Symptom,
Not Cause, of Eurozone Woes." Federal Reserve Bank of Richmond
Economic Brief 12-08.
Whelan, Karl. 2012. "TARGET2 and Central Bank Balance
Sheets." Available at
www.karlwhelan.corn/Papers/T2Paper-March2013.pdf.
(1.) Lubik and Rhodes (2012) provide a concise summary of ISA in
their essay on TARGET2. honing (2012) provides a more detailed
discussion of ISA, including a history of clearing and settlement across
Federal Reserve Banks. Eichengreen, Mehl, and Chitu (2013) also .discuss
that history--see Section 2.
(2.) The current system for accommodating deficits and surpluses
across Federal Reserve Districts dates back to 1975. See Eichengreen,
Mehl, and Chitu (2013) for a description and analysis .of the pre-1975
system, focusing on the period from 1913 to 1960.
(3.) Eichengreen, Mehl, and Chitu (2013) discuss how, before 1975,
instead of ISA there was a combination of settlement through transfer of
gold certificates (to be discussed below) and discretionary "mutual
assistance" among Reserve Banks.
(4.) All currency is designated as issued by one of the 12 Federal
Reserve Banks, and is marked with the corresponding district number and
letter. As this example suggests, however. currency does not necessarily
enter circulation in the district through which it is officially issued.
(5.) "Notes held by Federal Reserve Banks" appears on the
liability side of each Federal Reserve Bank's balance sheet.
However, on the liability side it is deducted from the value of Federal
Reserve notes outstanding. Thus, if a Reserve Bank has 810 billion in
notes outstanding, and holds Sim) million of notes in its vaults, then
its consolidated liability for these items is 89.9
(6.) Some forms of credit policy, for example the Term Auction
Facility. mit 'idly hit all the Reserve Bank balance sheets, to the
.extent that commercial banks in all 12 Districts borrow at the auction.
In contrast, the Maiden Lane facilities involved only the New York
Fed's balance sheet.
(7.) A complete list of purchases is available at
www.newyorkfed.org/markets/pomo/display/index.cfm.
(8.) In principle, a primary dealer's deposit account could be
with a bank located outside the New York Federal Reserve District. In
this case ISA would be involved in the initial transaction. For
simplicity we assume that the primary dealer's bank has a reserve
account with the New York Fed.
(9.) Data on swap line drawdowns are available at
www.newyorkfed.org/markets/fxswap/fxswap_recent.cfm, and a detailed
explanation of the swap facility is provided at
www.federalreserve.gov/monetarypolicy/bst_liquidityswaps.htm.
(10.) As described in the Appendix, it is possible for the gold
.certificate account to become negative in step 1. But any negative
balance would be reversed in step 2.
(11.) The Systemwide value of the gold certificate account has not
changed since 2006.
(12.) The foreign portfolio rebalancing in January would lead to
large ISA flows if there were a sharp divergence between Reserve
Banks' capital shares and their foreign portfolio shares. In order
for this to happen, there would have had to be large changes in capital
shares over the course of the year, presumably because of banking
industry restructuring.
(13.) We say "a form of credit" because the national
central banks and Federal Reserve Banks are only psendo-independent of
each other.
(14.) See the references mentioned in the Introduction.
(15.) For several of the national central banks, TARGET2 balances
are .easily accessible through the banks' official websites. The
website www.eurocrisismonitor.com provides updated time series of all
TARGET2 balances.
(16.) It should be noted as well that earlier (im)balances did tend
to be driven by differential economic activity activity regions, as
opposed to FOMC-directed securities purchases or swap line drawdowns.
(17.) The numbers in this paragraph are taken from the FDIC's
Summary of Deposits website, www2.fdie.gov/sod/.
(18.) See Keister and McAndrews (2009) and Ennis and Wolman (2012)
for additional details on the behavior of bank reserves and the Federal
Reserve System's balance sheet more generally.
(19.) The calculation for all 12 Banks is as follows: First,
calculate the weekly mean absolute balance across Banks, then average
that balance across time to arrive at $4.3 billion and $35.2 billion for
the two periods.
(20.) The number in the text is approximate because it is based on
the weekly I-1.4 data, which incorporate all factors that affected the
ISA during the week that settlement occurred.
