Gains for for­eign banks af­ter Fed rate liftoff

Financial Mirror (Cyprus) - - FRONT PAGE -

When the Fed­eral Re­serve de­cided to raise in­ter­est rates by 25 ba­sis points, there was grow­ing con­cern among many an­a­lysts, econ­o­mists and spec­u­la­tors that the move would hurt emerg­ing mar­ket economies.

How­ever, af­ter care­ful con­sid­er­a­tion it has now emerged that some of the big­gest ben­e­fi­cia­ries of the Fed in­ter­est-rate hike are for­eign-based bank­ing in­sti­tu­tions. Var­i­ous busi­ness units of th­ese off­shore banks were the re­cip­i­ents of ap­prox­i­mately $3.125 bil­lion in in­ter­est re­pay­ments made by the Fed­eral Re­serve Bank. The money that was paid out is known as re­serves, and it is de­posited and stored at the Fed­eral Re­serve Bank. Th­ese fi­nan­cial in­sti­tu­tions are in charge of ap­prox­i­mately 1/7 of to­tal as­sets held by banks in the United States.

The news from the Fed vis-a-vis in­ter­est pay­ments will bode well for th­ese for­eign banks since the in­ter­est-rate rose from 0.25% to 0.50%. And since it is ex­pected that the Fed will con­tinue rais­ing in­ter­est rates through­out 2016 – pro­vided the US econ­omy stays on track to­wards reach­ing its 2% in­fla­tion ob­jec­tive, and US eco­nomic data shows strong growth mov­ing for­ward – we could be look­ing at a rate above 1.2% within a year. The rate is oth­er­wise known as the IOER (In­ter­est on Ex­cess Re­serves Rate).

The rea­son why th­ese for­eign-based banks enjoy an un­equal share of the in­ter­est re­pay­ments that are made by the Fed are di­rectly at­trib­uted to the dis­pro­por­tion­ate share of to­tal re­serves held with the Fed by th­ese for­eign banks.

Fed­eral Re­serve Bank data re­flects that Amer­i­can agen­cies and branches of for­eign­based banks held over $880 bil­lion in re­serves by June 30, 2015. This fig­ure ac­counts for some 35% of all re­serves. If we ex­trap­o­late to the be­gin­ning of De­cem­ber 2015, it is clear that for­eign fi­nan­cial in­sti­tu­tions had de­posited for safe­keep­ing some $1.2 tril­lion with the Fed­eral Re­serve Bank. This ac­counts for al­most half of to­tal re­serves (47% in to­tal). Be­tween June and Novem­ber 2015, the av­er­age cash as­sets and other re­serves held by for­eign banks in the United States hov­ered around $1.1-1.2 tril­lion per month. This fig­ure in­cludes bal­ances due from fi­nan­cial in­sti­tu­tions, bal­ances owing from Fed­eral Re­serve Banks, vault cash, cash in col­lec­tion, etc.

Banc De Bi­nary an­a­lysts point out that the rea­son why for­eign banks have an un­usu­ally greater quota of re­serves with the Fed is a com­bi­na­tion of in­cen­tivised schemes and fi­nan­cial reg­u­la­tions. The FDIC (Fed­eral De­posit In­sur­ance Cor­po­ra­tion) re­ceives rev­enues in the form of pre­mi­ums from US char­tered banks. This also in­cludes for­eign bank­ing en­ti­ties. The ex­act amount that th­ese in­sti­tu­tions re­ceive ranges from 0.05% all the way up to 0.35%, con­tin­gent upon the as­set hold­ings of th­ese banks. The cal­cu­la­tions are com­plex; suf­fice it to say that it is a com­bi­na­tion of cash re­serves less var­i­ous cap­i­tal mea­sures. There are scores of fi­nan­cial en­ti­ties that are ex­empt from making pay­ment to the FDIC, no­tably those bank­ing in­sti­tu­tions that do not take de­posits, as well as Amer­i­can fi­nan­cial oper­a­tions that are in­cor­po­rated off­shore, and whose US-based fi­nan­cial in­sti­tu­tions do not ac­cept de­posits.

It is en­tirely pos­si­ble for US-based banks and for­eign-based banks to bor­row sub­stan­tial sums of money overnight at really low rates of in­ter­est. Th­ese are known as short-term in­ter­est rates, and the funds can be kept at the Fed for a higher rate. The spread is the in­ter­est rate dif­fer­en­tial be­tween the overnight bor­row­ing rate and the rate th­ese banks re­ceive when de­posit­ing with the Fed. Not all for­eign-based bank­ing in­sti­tu­tions have to pay the fees levied by the FDIC.

As a case in point, prior to the 0.25% rate hike, this fee paid by banks for overnight bor­row­ing in the short-term Fed­eral Funds Mar­ket was 0.13%. How­ever the earn­ings on re­serves amounted to 0.25%. The spread was there­fore 0.12% by com­par­i­son; US-based banks re­ceived a far lower spread of just 0.05%. Now that the Fed has hiked in­ter­est rates to 0.50%, the overnight bor­row­ing rate is 0.35% and the amount that they re­ceive on earn­ings is 0.50%. This leaves a spread of 0.15% for for­eign-based banks. How­ever, the dif­fer­en­tial is sub­stan­tially smaller for USbased banks which now only re­ceive ap­prox­i­mately 0.08%.

The in­tri­ca­cies of in­ter­na­tional fi­nanc­ing and reg­u­la­tion be­tween re­tail banks, whole­sale banks and the Fed­eral Re­serve Bank are com­plex. The spread is of­ten off­set in for­eign mar­kets, and reg­u­la­tory treat­ment varies from one mar­ket to an­other.

As can be seen from the in­creas­ing spread for for­eign banks af­ter the Fed rate hike, there will be tremen­dous in­ter­est in us­ing the Fed to pay more to for­eign-based banks now that the in­ter­est-rate has been in­creased to 0.50%. Ac­cord­ing to those in the know, the 25-ba­sis point rate hike will cost the US gov­ern­ment ap­prox­i­mately $13 bil­lion in an­nual re­pay­ments to for­eign banks. Of course re­serve lev­els need to be kept at their sta­tus quo, ce­teris paribus. There is a dis­pro­por­tion­ate ad­van­tage be­ing given to for­eign banks af­ter the Fed rate hike. Very lit­tle news has been cir­cu­lat­ing in the me­dia about the ef­fect of a rate hike, while most of the at­ten­tion is cen­tred on op­tions trad­ing, with cur­rency spec­u­la­tors hav­ing a field day, no­tably with the emerg­ing mar­ket cur­ren­cies.

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