Bill Nelson on Shrinking the Fed's Balance Sheet and Reviving Interbank Markets

Core argument. Bill Nelson's thesis, delivered in talks recently given at the ECB, Riksbank and back at the Fed itself, is that the US should follow the rest of the developed world toward a smaller Fed balance sheet and a market-based (rather than floor-system) way of implementing policy — and that the binding constraint isn't the Fed's asset holdings but bank liquidity regulation. "You have to reduce demand [for reserve balances] if you want to get smaller," and the key lever is fixing liquidity requirements (the LCR and related supervisory practice) so they stop treating reserve balances as the only acceptable form of self-insurance.

The mechanism. Nelson's case rests on dismantling what he calls basic misconceptions. First, that liquidity rules were designed to discourage discount-window borrowing — he says this isn't in the Basel LCR text or the US implementing rules, which instead explicitly permit committed liquidity facilities. Second, that central bank lending is inherently a crisis/bailout tool — historically, and at the Fed's 1913 founding, discount-window lending was the ordinary mechanism for converting collateral into currency or reserves, not an emergency backstop. Third, that only held liquid assets count as "self-insurance" while an established line of credit at the central bank does not — a distinction he says reflects roughly the last fifteen years of supervisory thinking, not how liquidity was understood before the GFC, when banks routinely met liquidity needs via credit lines and discount-window access rather than asset stockpiles.

Once liquidity rules recognize borrowing capacity, banks' demand for reserve balances falls, and the Fed can shrink its balance sheet further without breaking money markets. Nelson also points to concrete evidence that the mechanism already works: JPMorgan Chase's Fed account balance fell from roughly $400 billion at end-2023 to roughly $100 billion at end-2025, a move he attributes largely to repo rates rising relative to IORB, making it financially rational to run reserves down — the same dynamic he says drove JPM's 2018–19 reserve reduction.

Globally, the ECB, Riksbank, Norges Bank, Bank of Canada, Bank of England and RBA are all shrinking balance sheets partly, Nelson says, to revive dormant interbank markets — a goal he shares with BIS's Claudio Borio's framing that banks should look to the interbank market first and the central bank only as backstop. He notes the irony that European central banks — in a generally more left-leaning policy environment — are ahead of the Fed on this