OREANDA-NEWS. The drop in US money market funds' (MMFs) exposures to European banks at quarter end is becoming increasingly more pronounced, Fitch Ratings says. "Window dressing" by banks to improve regulatory figures at reporting dates is common practice, but recently enacted regulatory rules for European banks combined with MMFs' use of the Fed's reverse repurchase programme are likely exacerbating the quarterly fluctuations.

In Europe, the leverage ratio is reported quarterly and was initially calculated using the average of the month-end leverage ratios over a quarter. This was amended effective January 2015 to be calculated using a point-in-time quarter-end basis, to align with solvency reporting. This may have exacerbated intra-quarter fluctuations by incentivising banks to report lower balance sheet volumes on the last day of a quarter than they held during the quarter.

Regulators are attuned to "window dressing" and some require their banks to use averages of daily balance sheet exposures when calculating quarter-end ratios. In the US, the supplementary leverage ratio uses daily averages for on-balance sheet items and the average of three month-end calculations for off-balance-sheet items. UK banks will be required to report an additional leverage ratio using daily averages to their regulator starting 2017 and to publicly disclose this in 2018.

The UK regulator's action could lessen banks' incentives to adjust leverage ratios on any specific date. This may reduce the fluctuations in UK bank funding from US MMFs, so the trend could be more similar to the less volatile exposures of US banks. The different rules for calculating the leverage ratio give European banks (excluding the UK) additional balance sheet flexibility to temporarily manage down their exposure measures, barring any changes to the definition and calculation of the leverage ratio stemming from the Basel Committee's review by end-2016.

The Fed's reverse repurchase operations (RRP) may also be contributing to the increase in volatility in MMF exposure to European banks. MMFs' growing comfort with this alternative risk-free investment has driven them to increase allocations to the RRP, especially at quarter ends, when bank demand for dollar funding from MMFs ebbed. RRP assets at prime and government funds have topped or roughly equalled allocations to European banks each quarter end since December 2014.

Quarterly dips in the top 10 prime US MMFs' exposures to European banks emerged at end-2012. There was no visible seasonal pattern in 2011-2012 during the height of the eurozone sovereign debt crisis, when prime MMFs were sharply reducing their European exposures.

The quarterly dips became apparent by end-2012 as European exposures increased, coinciding with the implementation of the parallel run period for the Basel leverage ratio on 1 January 2013. The swings have become sharper, maybe as disclosure requirements for European banks became clearer in the lead-up to the public disclosure of the leverage ratio starting 1 January 2015.

Demand and supply-side dynamics will continue to contribute to shifts in MMF asset allocations, likely away from European banks and toward the Fed's RRP facility at quarter ends.