EC Did FRFA Crowd Out EU Banks?

Based on the latest report from Fitch, US money market funds’ exposure to European banks – dollar denominated commercial paper and repo loans to EU banks – declined by some 10% (in dollar terms) from the previous month (h/t Kostas Kalevras – @kkalev).
 

Source: Fitch

Fitch had a possible (and somewhat surprising) explanation. Could the Fed’s reverse repo program called FRFA that is currently being tested (see post) be crowding out European commercial paper?

Fitch: – The December decline in MMF allocations to European banks was largely offset by repo exposure to the Federal Reserve Bank of New York (FRBNY). The FRBNY has been periodically conducting overnight reverse repurchase agreement (RRP) exercises with market participants, including MMFs, to test how these operations might function as a policy tool for managing short-term interest rates. This technical exercise, in which FRBNY serves as the fund’s repo counterparty, accounted for 3.7% of all MMF assets within Fitch’s sample at end-December. By comparison, the MMF’s allocation to European banks declined by 3.8% (i.e. expressed as a percentage of MMF assets) in the course of December. It is unclear whether the FRBNY exercise might have crowded out some of the MMF allocations to European banks or whether the European reduction reflects a new equilibrium taking hold.

Another explanation is window dressing for year-end. Many investors review their money markets allocations once a year, often paying attention just to the year-end report. Showing a lower EU bank allocation number on that report could provide a marketing benefit.

Nevertheless this is something banks, both in the US and abroad, will need to consider going forward. As the FRFA’s scope increases, banks’ commercial paper and repo rates will need to rise in order to compete with the Fed for money market funds’ dollars. That of course is the purpose of the program – using the broad money market investor base to manage short-term interest rates.