Why ‘Ample Reserves’ May Not Be Enough to Keep Markets Calm

When U.S. overnight repo rates—the interest rate on repurchase agreements, a form of short-term borrowing in which investors exchange securities for cash and agree to buy them back the next day—surged to 7% in September 2019, the episode appeared to defy monetary logic. Banks were sitting on over a trillion dollars in reserves after years of quantitative easing. The Fed called the system "ample." Yet the world's most important short-term funding market briefly broke down.

A paper by Adrien d’Avernas (SHoF/SSE), Baiyang Han (Stanford), and Quentin Vandeweyer (University of Chicago) argues the conventional view was looking at the wrong thing. The problem wasn't a shortage of reserves overall—it was a shortage of reserves at the right moment during the trading day.

“Frequent disruptions in repo markets […] are particularly surprising as they take place after several rounds of quantitative easing,” the authors say. The surprise, they argue, comes from looking at the wrong margin.

Liquidity, But at the Wrong Time

Modern financial markets run continuously. Repos are rolled over during the day, margin calls are met in real time and large-value payments flow through settlement systems that do not wait for the close of business.

Before the global financial crisis, banks could manage these flows flexibly. Daylight overdrafts from the Fed allowed reserves, held by individual banks in their accounts at the Fed, to dip below zero temporarily, smoothing frictions.

“Intraday reserve flows are completely inconsequential as long as intraday overdrafts are accessible to banks,” the authors say.

That regime has ended. Post-crisis regulations, notably Basel III and the US’s Regulation YY, require large banks to pre-fund intraday outflows with reserves.

“Intraday liquidity regulations aim at avoiding the run-risks brought about when a large share of liquid assets are pledged to obtain intraday liquidity, as had been the case for Lehman Brothers on the eve of its bankruptcy in 2008,” authors say.

From Elastic Credit to Hard Limits

The authors describe the transformation starkly. Intraday liquidity regulation, they argue, “turns an elastic credit system into an inelastic token system”. Once banks exhaust their intraday buffers, they simply cannot lend more regardless of interest rates.

This matters because today’s repo market is dominated not by banks but by non-bank institutions such as hedge funds, which finance large securities positions but lack access to the Fed’s discount window. Banks sit between these shadow lenders and the central bank.

In normal times, banks arbitrage freely between the fed funds and repo markets, keeping rates aligned within the Fed’s policy corridor. Under intraday constraints, that arbitrage can abruptly fail.

“Once banks have reached that limit, they are unable to further lend in fed funds or repo markets,” the authors say. “As a consequence, the provision of repo supply is rationed, and its rate jumps up to the marginal cost of fire-sale portfolio liquidations for shadow banks, which cannot access the discount window.”

That mechanism explains why repo rates can spike not only above the Fed’s target range, but even above the discount-window rate, something traditional monetary models struggle to explain.

The authors note that related research suggests these disruptions may not be confined to funding markets. In follow-up work, d’Avernas, Vandeweyer, and Damon Petersen (MIT) study how repo market stress can spread to the Treasury market when banks face both leverage and intraday liquidity constraints.

A Different Measure of Scarcity

The authors construct a new metric—intraday excess reserves—defined as total reserves minus banks’ repo lending and minus peak intraday payment flows.

This, they argue, is “the relevant metric in this new regime”.

By that measure, liquidity was far tighter in 2019 than headline reserve figures suggested. Intraday excess reserves fell close to zero in the months before the September spike.

“Unlike overnight excess reserves, our intraday-adjusted metric is close to zero in 2019,” the authors note, precisely when markets cracked.

Rather than pointing to a simple shortage of reserves, the episode highlights how liquidity constraints can emerge during the trading day, even when balance sheets appear well supplied at the close of business. The authors argue that understanding these intraday dynamics is essential to explaining why short-term funding markets can become strained abruptly, and why interventions may be needed to restore smooth functioning despite apparently ample reserves.