Banks Increase their Holdings of Safe Assets
The banking sector seems to have transitioned to a new state in which a higher percentage of bank assets is held in safe forms. During the last recession, holdings of safe assets, such as cash, Treasury securities, and federal agency securities, rose steeply. But almost five years later, banks both large and small are still holding on to elevated cash levels and higher amounts of safe securities than before the recession. Many factors may have kept the trend going: the need to mitigate liquidity risks, a desire to prepare for expected regulatory changes, or an attempt to make banks worth more in a possible bankruptcy, to name a few.
A look at the data helps us distinguish between the probable causes of the trend. Cash may have been boosted in such a steep fashion during the recession because of the Fed’s increase in bank reserves. But other safe assets experienced a similar trend, without the sudden rise during the recession, which suggests deeper factors than the Fed’s actions are at play. New Basel III regulations on liquidity ratios could have motivated the trend, but these surfaced around December 2010, long after the trend was well established. Expected regulatory changes related to “too-big-to-fail” do not seem to be a dominant factor either, because banks both small and large have shared in the trend. The story most supported by the data is that the rise in safe assets may substitute for a lack of sufficient interbank liquidity, or as a signal by banks that they are safer, raising the liquidation value of their bank in default.
Cash levels at large domestic banks experienced a big spike during the recession, rising from about 3 percent of total assets to about 9 percent near the end of 2009. The trend seems to have settled, with the level now hovering around 8 percent. Treasury and agency securities levels had been declining since 2005, but the recession reversed the trend. Combined, holdings of these assets rose from around 10 percent at the beginning of the recession to about 15 percent in the first quarter of 2013.
Small banks exhibited nearly identical trends. Cash levels at small domestic banks spiked during the recession, rising from about 3 percent of total assets to about 8 percent near the beginning of 2010. The level now hovers around 8 percent. Holdings of Treasury and agency securities had also been declining at small banks before the recession but they reversed course during it. Holdings rose from around 11 percent in the recession to about 16 percent in the last quarter.
For this rise in safe assets as a percentage of assets to occur, a concurrent drop in some other category of assets should occur. It appears that category is loans and leases. Loans and leases dropped for the large domestic banks from over 60 percent before the recession to about 53 percent at the beginning of 2010. The trend steadied, and the level has hovered between 54 percent and 56 percent since.
We see a similar trend at small domestic banks. Loans and leases at these banks experienced a rise from 65 percent of total assets in 2005 to a bit over 70 percent in the recession, and then fell off a cliff to about 60 percent in the first quarter of 2013. The steep jump seen in March 2010 is a result of an accounting change, where banks took off-balance sheet items onto their balance sheet.
At large banks, other assets seem to have peaked in the crisis but returned recently to a slightly lower level than before the recession. Other securities seem to have been steady throughout.
At small banks, both other assets and other securities have stayed fairly close to their averages since 2005.
We see that during and after the last recession, the percentage of bank assets held in cash, Treasury securities, and agency securities experienced a steep rise, while loans and leases dropped. Other assets and other securities seem to have stayed almost steady.