Earlier this month, the Federal Reserve Bank of Dallas published a paper titled, "Network structure of money markets and firms affects policy transmission," which serves as an excellent primer and overview of a number of issues in the money markets. It explains, "Banks rely on an intricate network of money markets for liquidity management, including brokered deposits, commercial paper, Federal Home Loan Bank advances, federal funds, Eurodollars and selected deposits and repurchase agreements. Different types of financial institutions participate in individual money markets, and the relationships between market rates are influenced by cross-product elasticities and arbitrage. The pass-through efficiency of policy rates, as measured by dispersion in money market rates, is highest when money market rates are close to the rate of interest on reserves. Understanding the underlying network structure of money markets provides valuable insights for monitoring reserve conditions and their evolution in response to regulatory and market changes." (Note: For those looking to learn about the money markets, Crane Data will be hosting its "basic training" Money Fund University, Dec. 18-19 in Pittsburgh. We're also exhibiting at the AFP 2025 annual treasury conference in Boston (10/26-28). We hope to see you there!)
The paper states, "Most advanced economy central banks before the Global Financial Crisis (2007–08) used scarce reserves frameworks under which policy rates were highly sensitive to reserve supply. A central bank could achieve a specific target rate by adjusting the reserve supply. In the ample reserves framework now used in the United States, interest rate sensitivity to reserve supply is moderate, limiting the practicality of rate control via reserve supply. Instead, target rates are primarily controlled through administered rates, which offer outside lending and borrowing options to certain market participants."
It continues, "Banks provide liquidity and maturity transformation, an essential function of the financial system. Central to this function is the management of liquidity balances, most importantly reserves. They are claims on the central bank that allow banks to settle interbank obligations. Money markets, which allow both banks and their nonbank clients to rebalance their liquidity, are essential to liquidity management. Money markets and the types of firms that participate in them are heterogeneous and form a complex network. Changes in policy instruments -- such as the supply of reserves or administered rates that touch on one part of the network -- ripple outward through the rest of the network."
The Dallas Fed writes, "While reserves can be traded directly (as in the federal funds market), most liquidity management transactions that give rise to reserve reallocation between banks occur in other money markets. Liquidity management can be highly complex, depending on the structure of a bank's liabilities, the transaction flow of its deposit customers and the liquidity of its assets."
They comment, "Bank treasurers rely on a variety of money markets for short-term liquidity management, including brokered deposits, commercial paper, Federal Home Loan Bank advances, federal funds, Eurodollars and selected deposits, and repurchase agreements (repo). Banks may also choose to rely on liquidity provided by the official sector, such as primary credit at the Fed discount window, which can be priced competitively with certain market segments and is intended to provide healthy banks with adequate liquidity in support of monetary policy transmission. Additionally, banks manage their liquid assets to adjust their liquidity positions, implicitly relying on market provision of liquidity, though this is outside the scope of this discussion."
The piece tells us, "It is instructive to view the various money markets from the perspective of a bank treasurer. Domestic banks generally rely on long-lived, stable deposits from households and nonfinancial businesses. But it is often not optimal to hold a liquidity buffer against all possible demands, and customer deposits are impractical and expensive to source on short notice. A treasurer's choice of liquidity source is determined by price, tenor (or term), settlement timing, market access and operational capacity. Differences in market access and operational capacity between large and small banks drive significant differences in the sources banks tap. Among foreign banks, restrictions on their ability to hold retail deposits in the U.S. (and elsewhere) steer them toward a different mix of liquidity sources than their domestic counterparts."
It says, "As a result, different types of financial institutions are active in different money markets. Entities include U.S. and foreign depositories of various sizes, dealers, money market funds, corporate treasurers, Federal Home Loan Banks and other nonbank financial institutions. The relationship between rates in different markets is thus determined by cross-product elasticities, a result of firms substituting between the various markets in which they borrow or lend, and arbitrage (firms simultaneously borrowing in one market and lending in another). One can think of the activity of different types of entities in different markets as a bipartite, directional graph, with this network represented as a matrix."
The paper also states, "The brokered deposit market allows banks, with the permission of their customers, to lend such deposits to other insured depository institutions via third-party brokers. This market is a small subset of the overall deposit liabilities of domestic banks. However, it is of outsized importance for banks' marginal liquidity needs. Banks of all sizes, especially community banks, rely on brokered deposits for this purpose. While this market is less well-documented than other money markets because it is relatively opaque, the outstanding volumes are typically around $1 trillion (excluding reciprocal deposits), making it one of the largest sources of wholesale funding for domestic banks."
It says, "CP is one of the oldest money markets and plays an important role financing some large financial institutions, though the market became smaller following the Global Financial Crisis and the ensuing money market fund reforms. Financial institution CP outstanding totals about $670 billion. The CP market is only a practical source of financing for relatively large issuers, who frequently issue directly to the market. Foreign banks frequently play a large role in issuance due to their dollar funding needs and lack of access to retail deposits. Lenders in this market are often prime money market funds, corporate treasurers and nonbank financial institutions. CP maturities are as short as one day but more frequently are around one month."
The Dallas Fed adds, "Like brokered deposits, Federal Home Loan Bank advances are a significant source of marginal liquidity for primarily small institutions, though banks of all sizes use these advances to optimize their liability structures. Advances owed by commercial banks vary significantly over time. They were around $500 billion as of first quarter 2025. While most advances are for a year or less, longer-tenor borrowing is available."
They write, "The federal funds market, often referred to as fed funds, is a primarily overnight market for liquidity between institutions that can hold reserve balances, including banks and government-sponsored enterprises. While it is a historically important money market -- it is the market that informs the effective federal funds rate, the Federal Open Markets Committee's policy target -- volumes in this market declined following the Global Financial Crisis. Activity now mostly reflects Federal Home Loan Bank lending to foreign banks. Federal Home Loan Banks need to hold liquidity balances intraday to meet client demand for advances. Thus, they value the early morning return of cash that occurs when lending overnight in fed funds. Because foreign banks are unable to hold retail deposits, this wholesale channel is especially valuable to them as a source of liquidity."
Finally, they tell us, "Eurodollars refer generally to U.S. dollar deposits held at banks outside the United States. This broader market has played a central role in the history of global finance since World War II. A portion of this market is captured in regulatory reports when banks borrow funds via a non-U.S. branch that are then transferred back onshore within the borrowing institution. 'Selected deposits' refer to uncollateralized interest-bearing domestic deposit liabilities with short and fixed terms. These are very similar to Eurodollars but are booked in domestic bank offices. Both Eurodollars and selected deposits are used similarly to fed funds; the main borrowers in these markets are foreign banks. However, unlike fed funds, the primary lenders in these markets are nonbank financial institutions." (This excerpts from just the first half of the paper; watch for the second half in coming days.)
