Informal Supervisory Bias: How It Develops
Bank examiners are human beings operating within institutional cultures shaped by decades of experience. For much of the post-2008 period, large banks operated in an environment of superabundant reserves — reserves were the overwhelmingly dominant form of bank liquidity, and examiners became accustomed to evaluating liquidity health through the lens of reserve balances.
As a result, even though Treasury bills are legally equivalent to reserve balances as Level 1 HQLA under the LCR, informal examiner culture has developed a preference for reserves. Anecdotal evidence from industry participants — documented in Afonso et al. (2024) and discussed in the paper — suggests that banks may receive informal feedback from examiners suggesting they hold more reserves relative to T-bills, even when regulatory rules make no such distinction.
This informal bias, if widespread, inflates aggregate reserve demand beyond what formal regulations require. Banks respond to the examiner's implicit preference even when the regulatory rulebook says reserves and T-bills are equivalent — because examiner opinions feed directly into CAMELS ratings, enforcement actions, and the regulatory relationship that matters for a bank's business operations.
The Policy Option
Issue explicit interagency supervisory guidance — via SR letters from the Fed and parallel guidance from OCC and FDIC — instructing examination teams to treat Treasury bills and reserve balances as strictly equivalent in all liquidity stress reviews and informal feedback. Guidance would explicitly prohibit examiners from suggesting banks hold more reserves relative to T-bills for supervisory compliance purposes, absent a specific demonstrated reason related to operational (intraday settlement) needs.
Complementarily, examiners could be retrained via internal training programs and examination manuals to explicitly document the equivalence principle, making it part of the examination checklist rather than dependent on individual examiner judgment.
Why the Effect Is Modest
The estimated effect is relatively small ($25–50 billion) compared to regulatory options. This reflects two limitations: first, the magnitude of informal bias is inherently hard to measure — it may be larger or smaller than industry complaints suggest. Second, even if examiners fully equalize treatment, banks may independently prefer reserves for operational reasons (intraday settlement, payment system participation) that are unrelated to examiner preferences.
Nonetheless, the paper argues this option is among the lowest-cost interventions available — it requires no statutory change, no formal rulemaking, and no quantitative threshold decisions. It is a straightforward communication of an existing legal principle to examiners who may not be applying it consistently.
Modest but certain; lowest implementation cost among all 15 options. Primarily targets informal bias rather than formal regulatory constraint.
Measurement Challenge
A key challenge is measuring success. Because the bias operates informally, there is no direct metric to track whether equalization has occurred. Proxy measures — such as aggregate bank T-bill holdings relative to reserves, or survey data on bank liquidity management preferences — could be monitored, but attributing changes to this specific policy versus other factors is inherently difficult. The paper recommends coupling this option with data collection on bank liquidity composition at the examination level.