| Abstract |
This paper examines how foreign banks constrain the Federal Reserve’s ability to shrink its balance sheet under the ample-reserves framework. Although they represent a small share of traditional U.S. banking business, foreign banks hold a disproportionately large share of reserves at the Federal Reserve. Their demand is highly elastic, shaped by global regulatory asymmetries and cross-border arbitrage incentives.
Using regulatory and high-frequency data, we document systematic differences in reserve management across bank types. Exploiting exogenous variation in supply shocks, we show that reserve demand is heterogeneous and asymmetric across policy regimes: foreign banks absorb most inflows during quantitative easing (QE), but adjust less during quantitative tightening (QT), when large domestic banks shed reserves more actively. We develop a heterogeneous-demand model that links these behaviors to the aggregate reserve demand curve and shows that uncertainty specific to foreign banks increases the Federal Reserve’s optimal reserve supply during QT. |