James McAndrews says a fundamental shift in the way the Federal Reserve interacts with the American financial system is coming. Soon.
He should know. The former co-director of research at the New York Fed, McAndrews spent the better part of three decades behind the scenes for some of the central bank’s biggest changes.
Now, as chairman and chief executive officer of TNB USA Inc., the 59-year-old plans to be at the vanguard of the next major evolution. It’s one he says is all but inevitable: the emergence of ultra-safe, razor-focused private banks whose singular purpose is to allow institutional investors to park cash at the Federal Reserve.
There’s just one problem. The Fed seemingly wants nothing to do with him. So two months ago TNB -- which stands for the narrow bank -- sued McAndrews’s former employer. It’s trying to force the central bank to let it open an account that earns the same top-tier interest rate currently available only to a select few, which it will then pass on to depositors. If successful, TNB is poised to disrupt America’s multitrillion-dollar short-term funding markets, the rates hundreds of millions of Americans get on their savings, and some say the Fed’s policy setting mechanism itself.
“The narrow bank potentially changes the dynamic,” said Alex Roever, head of U.S. rates strategy at JPMorgan Chase & Co. “If you have several of these entities emerge, they can be much more competitive taking on large-scale deposits. That probably pulls money out of other places, maybe out of banks that can’t afford to stay competitive, maybe out of some of the money-market fund options. It creates some price competition and creates opportunities for institutions with cash to try and put it to work.”
The genesis of the narrow bank can be traced back to 2006, when the Financial Services Regulatory Relief Act gave the Fed, for the first time, the power to pay commercial banks interest on reserves. Two years later, policy makers put that power to use, seeking to help ease crisis-era credit strains by giving lenders incentive to leave funds at the central bank.
That created an opening for private-sector institutions to more closely channel Fed rates to a wider audience and, indirectly, play a role in monetary policy.
“What Congress did was really the sea change that led to the narrow bank,” McAndrews said in an interview at Bloomberg’s New York headquarters. “I see TNB as a subsidiary innovation that was called forth by the payment of interest on reserves itself. I have very little doubt that, in some number of years, narrow banks will be an everyday part of our financial system.”
At present, only a relatively small group of commercial banks with master accounts at the New York Fed are able to earn what’s known as the interest on excess reserves rate from the government on their deposits. A handful of other financial institutions also have access to the central bank’s overnight reverse repurchase agreement facility, which pays less.
McAndrews wants to expand access to the IOER rate in a big way. If the narrow bank can compel the Fed to play ball, and it’s able to attract a critical mass of deposits, market participants expect the knock-on effects to reverberate across the financial system.