Fidelity’s closure of some prime money-market funds is a negative omen for non-U.S. Banks
By Mike Bird
For Japan’s banks, lending in dollars has been far more profitable than lending in yen.
Photo: philip fong/Agence France-Presse/Getty Images .
Last week, Fidelity Investments said it would close two institutional prime money-market funds with a total of around $14 billion in net assets. That’s an ominous portent for some non-U.S. banks, which have increasingly come to rely on such funds to raise dollars they can’t easily acquire at home.
Fidelity cited volatile outflows from the funds—which invest in short-term commercial paper and certificates of deposit issued by companies—and into government money-market funds during moments of market stress. Fidelity’s retail prime money-market funds, whose assets run into the hundreds of billions, will remain open.
But non-U.S. banks will feel the loss: 20% of the Prime Reserves Portfolio, the larger of the two funds being closed, is invested in certificates of deposit, all issued by Canadian, Japanese and European banks. Many have increasingly strayed into dollar-denominated lending in recent years.
Low as the returns are, they’re better than what they could earn at home. In Japan in particular, the spread between short- and long-term yen-denominated interest rates has been squeezed narrower and narrower over time, making dollar lending far more profitable. To fund that longer-term lending—in the absence of dollar deposits—foreign banks have used short-term CDs.
The closures don’t mean an imminent funding crunch. But they are still bad news for the banks, watching one of their limited avenues for profit in recent years slowly closed off.
Certificates of deposit simply may not be an attractive investment in a lower-for-longer interest-rate environment like today’s. Investors will always look for incremental additional returns, but for much of 2014, when conditions were similar, 3-month CDs offered a yield less than 0.1 percentage point higher than U.S. Treasury bills of the same maturity. That’s measly compensation for an asset class that carries at least some credit risk.
The spread surged beyond 2 percentage points during the most panicked days of March, but is now again below 0.1 percentage point, somewhat lower than for most of the past few years.
Of course, banks can always offer investors higher returns on their CDs, but that would undercut the gains from their dollar-denominated lending.
In March, the surge in borrowing costs for foreign entities trying to obtain dollars using cross-currency basis swaps was a result in no small part of investors pouring out of prime money-market funds, draining them of more than $150 billion. Issuance fell by than half from late February into March.
This time, the immediate risk isn’t that funding violently dries up again, but that the dollar business foreign banks have engaged in slowly comes to make less and less economic sense.
That source of earnings will be sorely missed, given how few other options are available.
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