Working Paper

Explaining the Life Cycle of Bank-Sponsored Money Market Funds: An Application of the Regulatory Dialectic

Abstract: In this paper, we present empirical evidence of the regulatory dialectic in the prime institutional money market fund (PI-MMF) industry. The “regulatory dialectic”, developed by Kane (1977, 1981), describes how banks and regulators react to each other. For decades, a cap on commercial deposit interest rates fueled dramatic growth in bank-sponsored PI-MMFs as a form of shadow banking. During the growth period, banks with more commercial deposits were more likely to enter the PI-MMF industry in an effort to keep their commercial customers in affiliated subsidiaries. However, the 2008 crisis and subsequent regulatory changes halted the rapid growth of PI-MMFs. In the post-crisis regulatory regime, bank-sponsored funds were more likely to exit the industry than nonbank-sponsored funds. Simultaneously, the industry shifted from PI-MMFs to government institutional MMFs as substitute products. We conjecture that the collapse of the PI-MMF can lead further to the emergence of substitute products, such as stablecoins as part of the continuing dialectical process.

Keywords: bank; bank holding company; bank run; financial crisis; liquidity risk; money market funds; systemic financial risk; too big to fail;

JEL Classification: G2; G21; G23; G28; H12; H81;

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Bibliographic Information

Provider: Federal Reserve Bank of Kansas City

Part of Series: Research Working Paper

Publication Date: 2024-02-05

Number: RWP 24-01