Academic Articles

When the Federal Reserve (Fed) expanded its balance sheet via quantitative easing (QE), commercial banks financed reserve holdings with deposits and reduced their average maturity. They also issued lines of credit to corporations. However, when the Fed halted its balance-sheet expansion in 2014 and even reversed it during quantitative tightening (QT) starting in 2017, there was no commensurate shrinkage of these claims on liquidity. Consequently, the financial sector was left more sensitive to potential liquidity shocks, with weaker-capitalized banks most exposed. This necessitated Fed liquidity provision in September 2019 and again in March 2020. Liquidity-risk-exposed banks suffered the most drawdowns and the largest stock price declines at the onset of the Covid crisis in March 2020. The evidence suggests that the expansion and shrinkage of central bank balance sheets involves tradeoffs between monetary policy and financial stability.

With the failure of Silicon Valley Bank in March 2023, the concentration risk in bank liabilities has come under scrutiny. We use detailed security-level holdings of U.S. Money Market Mutual Funds (MMFs) that fund banks to introduce a novel measure of portfolio similarity among investors. Our findings suggest that MMFs actively manage their asset holdings based on the similarity of their portfolios with those of other investors. Specifically, when portfolios are more similar, investors are less likely to roll over investments, anticipating higher expected joint liquidation costs when portfolios are more similar. At the issuer bank level, the average similarity of its investors' portfolios is a reliable predictor of the bank’s total funding in the following period. Importantly, banks are unable to fully compensate for the loss of funding when similar investors withdraw.