Last year and earlier this year, debate concerning the Target2 mechanism in Europe and its growing imbalances shed some light on the equivalent institution in the US, the Interdistrict Settlement Account (ISA). The argument has been made to import the ISA structure into Europe, in particular, the yearly settling of accounts between district Reserve banks. If the ECB were to operate this way, the idea goes, then there would be some sort of quid pro quo on Target2 imbalances - European national central banks (NCBs) would not be able to accumulate debts to each other ad infinitum.
The observation was made that contrary to what one might expect, the ISA at the time did not seem to be balancing. Thus the idea that adoption of the Fed model would impose "firm limits" on intra-Eurosystem credit is invalid, since the Fed doesn't seem to always impose settlement on district Reserve banks. This April, though, the ISA seems to have been settled, as the charts below will illustrate. Nevertheless, the point still stands that the Federal Reserve System may choose to constrain itself by requiring interdistrict settlement or it may choose to forego that restraint.
To illustrate how the ISA typically settles, the chart below shows the Federal Reserve Bank of New York's ISA account (the red line) prior to the financial crisis. When positive, this represents the full amount that the FRBNY is owed by all other district Reserve banks. When negative, it represents the amount the FRBNY owes all other districts.
Each April, settlement occurs. The FRBNY's average ISA balance over the course of the previous 356 days is calculated (the dark red line). If this amount is positive, then the FRBNY receives that amount in securities from other banks, and its amount owed falls by the value of transferred securities.
Since the 356 day average will almost always differ from the net amount owed in early April, the balance needn't fall to zero so as to perfectly settle the account. If the 356-day amount is negative, the FRBNY pays that amount in securities to other district banks, and its amount owing falls.
Except for April 2003, from 2003-2008 the FRBNY was generally in deficit to other district Reserve banks (the red lines below zero). Each April it was required to transfer securities to these banks, as represented by the sharp upward movements in its ISA account in April 2005, 2006, 2007, and 2008. Settlement in April 2004 would have required only a token amount of securities, since the 52-week average FRBNY ISA balance was near zero. Thus a visual inspection of the FRBNY's ISA account shows no apparent change.
The next chart brings the credit crisis and aftermath into the story, a time over which the FRNBY's ISA balances grew tremendously. Investors fled to New York banks in September 2008, and though New York's ISA balance declined back into negative territory by early 2009, its 52-week average balance was still quite high by April 2009 settlement period, resulting in a transfer of securities from other districts to the FRBNY and a fall in its ISA balance (to even more negative territory).
For the April 2010 settlement period, the FRBNY's 52-week average balance remained in positive territory, and, as a result, it again received securities so as to settle. Its ISA balance that April fell by about $50 billion, apparent on the chart.
The anomaly appears in April 2011. The FRBNY was owed around $300 billion at that point in time. The 52-week average of its ISA balance was slightly lower at around $150 billion. Thus to settle, the FRBNY should have received around $150 billion and its ISA balance should have fallen from $300 billion to $150 billion. But New York's ISA balance hardly changed. The obvious conclusion, giving this anomaly, is that the Fed chose to forego settlement that April.
Through the rest of 2011 and early 2012 the FRBNY's ISA balance remained high and the 52-week average of its balance steadily rose. But in April 2012 settlement, the system seems to have finally settled. Some $200 billion worth of securities were transferred to the FRBNY from other district Reserve banks, and as a result the FRBNY's ISA balance fell towards zero.
The upshot is that the Fed can impose settlement on district Reserve banks or it can avoid it. Those in Europe looking to the US for an example of "hard" intrabank settlement among NCBs should look elsewhere.
Note: Credit Suisse's Economics Research team has some notes here on the ISA which mentions yours truly.
Post a Comment