110317 Beyond Unintended Consequences 1

Beyond Unintended Consequences: Changes to Foreign Branch Behavior Illustrate Overlooked System-Wide Regulatory Effects

Nov 03, 2017

The interaction of unconventional U.S. monetary policy by the Fed and regulatory changes by the Federal Deposit Insurance Corporation (FDIC) and the Securities and Exchange Commission (SEC) changed the way foreign banks do business in the U.S.

Three key policy and regulatory changes led to this behavior by foreign banks:

  1. The Fed’s introduction of interest on excess reserves
  2. A widening of the FDIC assessment base that increased the cost of deposit insurance
  3. New rules for money market funds in 2016 that shifted funds out of institutional prime money market funds (MMFs) into government MMFs

This paper argues that foreign branches were not the intended targets of these changes, yet these processes together still induced a significant shift in foreign branches’ prevailing business models. This is why the authors of this report advocate a holistic approach toward policy design that considers the system-wide impact of such actions and is mindful of how all the participants in the financial system are adjusting.

Avoiding piecemeal, ad hoc regulatory changes by taking a holistic approach toward policy design is a crucial lesson that has not been adopted by those engaged in formulating macroprudential policy. We continue to call for regulators to consider the system-wide impact of their actions and to recognize the limitations as well as the unintended consequences of their policy initiatives.