Quantitative Easing's Effect on Shadow Banking: Have Federal Reserve Purchases Caused a Collateral Shortage in the Repurchase Agreement Market?

• Main Author: Schaible, Amanda A
• Format: Others
• Published: Scholarship @ Claremont 2014
• Subjects: quantitative easing; shadow bank; repurchase agreement; shadow banking; repo; federal reserve; Finance; Macroeconomics
• Online Access: http://scholarship.claremont.edu/scripps_theses/423; http://scholarship.claremont.edu/cgi/viewcontent.cgi?article=1442&context=scripps_theses

Since the start of the financial crisis in 2008, the Federal Reserve has been engaging in quantitative easing. Quantitative easing is a form of open market operation in which the Federal Reserve buys long-term U.S. government and other securities, versus traditional open market operations that occur through the short-term Treasury bill market. At the same time, the shadow bank system, which is a system of financial intermediaries that perform unregulated credit intermediation outside of traditional banks, has contracted significantly. Some argue that this contraction is due to a collateral crunch induced by quantitative easing in the shadow bank system—a crunch that occurred when the Federal Reserve’s quantitative easing program took high-quality collateral off the market. I will focus specifically on repurchase agreements, an instrument within the shadow banking that uses the same types of securities that the Federal Reserve has been buying during quantitative easing as collateral, to determine whether quantitative easing has led to a contraction of the repurchase agreement market. I find that increases in Federal Reserve asset holdings from 2005-2013, and specifically during QE1, are associated with decreases in primary dealer repurchase agreements. This shows that under certain circumstances, Federal Reserve asset purchases lead to contractions in the shadow bank system. This paper aims to increase understanding of how monetary policy affects shadow banking and understanding of the unintended consequences of monetary policy, such as decreased shadow bank lending caused by quantitative easing.