Kevin Warsh discussed his views on monetary policy, Fed independence, and the balance sheet during his confirmation hearing. If confirmed, he aims to gradually shrink the Fed’s balance sheet. As shown on Slide 1, while the $3 trillion in reserve deposits has remained stable since 2022, M2 has continued to grow, increasing by $1 trillion to $23 trillion over the last 12 months. Most banks hold minimal reserves at the Fed relative to their total assets, as shown in Slide 2.

The Fed is exploring ways to reduce reserve demand on its balance sheet, which could lead to a smaller footprint, since reserve deposits account for nearly half of the balance sheet. Slide 3 reviews options for accomplishing this goal, like adjusting liquidity requirements and crediting banks for unused lines with the discount window.

The stigma of borrowing from the Fed as a last resort discourages bank treasurers from using it for contingency funding, even as Primary Credit borrowings are up by $2 billion since the war began, to nearly $6 billion (Slide 4). The Standing Repo Facility, providing emergency funding to banks and nonbanks (Slide 5), has also seen increased use over the last six months.

Conversely, banks rarely use daylight overdrafts (Slide 6) to cover shortfalls when making FedWire payments, a practice that was more common before the Fed expanded its balance sheet in 2008. Today, a bank treasurer with low reserves in the morning waits for incoming payments before making outgoing ones, which can cause jams and spike money market rates, especially in Treasury Repo, as happened several times, including September 2019, early COVID days, and March 2023, after Silicon Valley and Signature Bank failed.

Negative Treasury remittances flattened out this year as the Fed broke even between the interest it earned on its bond portfolio and the interest it paid on reserves. However, the Fed still owes $260 billion to the U.S. Treasury due to negative remittances. Repaying these reduces reserve deposits. Currency, equal to $2.5 trillion, grew by 1% in FY 2024 and 2% in FY 2025, but leaped to 7% YTD in 2026. Every dollar of printed currency decreases reserves equally.

Bank executives are optimistic about making loans this year, but FDIC data shows that last year's most active lending was to non-deposit financial institutions. Commercial and industrial lending is flat and shrinking as a percentage of total loans. However, credit risk remains benign.

Bank executives claim AI reduces headcount and boosts productivity, but FDIC data (Slide 10) shows no decline. Headcount peaked before the Global Financial Crisis at over 2.2 million and has stayed flat at 2.1 million, despite the number of banks halving in 20 years (from 8,680 to 4,336).