Fed Official Signals Bank Regulation, Not Market Operations, Is Key to Smaller Balance Sheet

A New York Fed official has stated that the key to further shrinking the Fed's balance sheet lies in reforming bank liquidity regulations, not just in its market operations.

The Fed is successfully maintaining tight control over its policy interest rate using its current tools, which reduces near-term market risks.

The future size of the balance sheet now depends on coordination between the Fed and bank supervisors, with potential for a smaller footprint if regulations are adjusted.

A top New York Fed official has reframed the debate over the central bank's size, suggesting the path to a smaller balance sheet now runs through bank regulation, not just monetary policy operations.

For context, the Federal Reserve has already significantly reduced its balance sheet, which swelled during the pandemic, from a peak of nearly $9 trillion down to about $6.6 trillion. This process, known as Quantitative Tightening (QT), was recently paused. In December 2025, the Fed switched to making "Reserve Management Purchases" (RMPs) to ensure the banking system maintains 'ample reserves'—enough cash for banks to operate smoothly without causing volatility in short-term interest rates.

This shift highlights the Fed's confidence in its operational toolkit. According to NY Fed's Roberto Perli, tools like RMPs, the Standing Repo Facility (SRF), and interest on reserve balances (IORB) are working exceptionally well. The proof is in the data: the Fed's key policy rate remains stable and under firm control, which means the market's "plumbing" is not at risk. These RMPs are technical adjustments to maintain stability, not a form of economic stimulus.

So, if the tools are working, what's stopping the Fed from shrinking its balance sheet further? Perli's answer is bank regulation. The core idea is that banks currently hold large amounts of reserves partly because of strict liquidity rules like the 'Liquidity Coverage Ratio (LCR)'. If regulators were to tweak these rules—for example, by allowing banks to count access to the Fed's emergency lending facilities towards their liquidity buffers—banks would feel comfortable holding fewer reserves. This would naturally reduce the system-wide demand for reserves, allowing the Fed to safely operate with a smaller balance sheet.

This shift in focus creates a new dynamic. It's no longer just a technical question for the Fed's market desk but a coordination challenge with bank supervisors. This path isn't without obstacles, though. Fed Governor Michael Barr has cautioned against easing liquidity rules simply to shrink the Fed's footprint, highlighting a potential conflict between monetary policy goals and financial stability concerns. On the other hand, officials like Stephen Miran and Lorie Logan have supported exploring regulatory changes as the primary way forward.

Ultimately, Perli's message clarifies the road ahead. The Fed has proven it can effectively manage interest rates with its current tools. Therefore, the future size of its balance sheet hinges on whether regulators decide to reform liquidity rules. Without those changes, the Fed will likely continue using RMPs to keep reserves ample, and its balance sheet will remain near current levels.

Fed's Balance Sheet: A statement of the assets (like government bonds) and liabilities (like currency in circulation and commercial bank reserves) held by the Federal Reserve. Its size affects the money supply and credit conditions.
Ample Reserves: A state where the supply of reserves in the banking system is large enough that the Fed can control its policy interest rate without frequent, active market interventions.
Liquidity Coverage Ratio (LCR): A post-crisis regulation requiring banks to hold enough high-quality liquid assets (like cash reserves) to survive a 30-day period of significant financial stress.

Fed Official Signals Bank Regulation, Not Market Operations, Is Key to Smaller Balance Sheet

A New York Fed official has stated that the key to further shrinking the Fed's balance sheet lies in reforming bank liquidity regulations, not just in its market operations.

The Fed is successfully maintaining tight control over its policy interest rate using its current tools, which reduces near-term market risks.

The future size of the balance sheet now depends on coordination between the Fed and bank supervisors, with potential for a smaller footprint if regulations are adjusted.

A top New York Fed official has reframed the debate over the central bank's size, suggesting the path to a smaller balance sheet now runs through bank regulation, not just monetary policy operations.

Fed's Balance Sheet: A statement of the assets (like government bonds) and liabilities (like currency in circulation and commercial bank reserves) held by the Federal Reserve. Its size affects the money supply and credit conditions.
Ample Reserves: A state where the supply of reserves in the banking system is large enough that the Fed can control its policy interest rate without frequent, active market interventions.
Liquidity Coverage Ratio (LCR): A post-crisis regulation requiring banks to hold enough high-quality liquid assets (like cash reserves) to survive a 30-day period of significant financial stress.