The inability of the big four U.S. banks to lend cash in tandem with a surge in competition from hedge funds for backed liquidity may clarify a recent spike in the U.S. money market levels said the Bank for International Settlements.
Cash available to lenders for short-term lending all but dried up at the end of September, as interest rates embedded in U.S. financial markets' pipes soared to double digits.
For the first time since the global financial crisis more than a a decade ago, it prompted the central bank to make an emergency infusion of billions of dollars.
While the exact cause of the strain remains unknown - with reasons varying from massive quarterly tax payment deductions to a large settlement of a U.S. deal, treasury analysts said the growing reliance on the largest U.S. banks to keep the repo market working could have been a major factor.
Flexibility, Leverage
The big four banks that BIS has not named in its report have become net providers of funds for repo markets as they account for more than half of all Federal Reserve Treasuries held by U.S. banks.
The lending sector funds much of the U.S. financial system, helping ensure that lenders have flexibility to fulfill their day-to-day business needs.
Wall Street firms and banks are offering U.S. services in a repo trade scheme. Treasuries and other high-quality bonds as leverage for collecting money, sometimes immediately, to fund their exchange and loans.
Typically, the system hums along with the interest rate charged on repo deals hovering close to the Fed's overnight benchmark rate, which it cut from 2 percent to 2.25 percent on Wednesday.
Depleted Reserve
Yet the bank's interest rates soared up to 11 percent for some overnight loans by the end of September, more than four times the Fed's policy threshold, raising concerns about the fragility of U.S. dollar borrowing markets.
Meanwhile, the Federal Reserve started to run down its $4 trillion-plus balance sheet, while its U.S. holdings were also contracted by banks' cash reserves. Treasuries have been growing rapidly, the BIS disclosed.
That reduction in the central bank's cash holdings accelerated following the suspension of the US debt ceiling in early August. Between August 14 to September 17, the Treasury depleted more than $120 billion in assets, diminishing the major four banks' liquidity balances and thus their ability to invest in the repo sector, the BIS reported.
