Basel liquidity rules block Fed’s QE exit

LCR and NSFR could produce $1 trillion shortfall in plans for balance-sheet ‘normalisation’

"Returning to a small balance sheet... is not consistent with the LCR requirement," says Stanford's Darrell Duffie

Image: Stephen Lee, NB Illustration

After flooding the market with liquidity for the better part of a decade, the US Federal Reserve has begun tightening the spigot. Over the next five years, its asset portfolio will shrink by as much as $1.9 trillion as a result of ‘balance sheet normalisation’, which started in October 2017.

This reduction in the Fed’s balance sheet assets must be matched on the liability side by a decline in reserve balances, which banks maintain for liquidity purposes. To put it another way, the Fed’s