Eleventh District Banking Conference - Fireside Chat with Lorie Logan

Good morning. Thank you Emily for the very kind introduction and I just want to take a moment just to express my deep gratitude for Emily for her leadership here at the Federal Reserve Bank of Dallas. She's an incredible leader and we are so fortunate to have her. I also just want to extend my thanks to all of you who are joining us for our third annual 11th District Banking Conference. I'm really excited by the opportunity to gather both bankers, regulators, and supervisors all in one room to talk about banking conditions and risks. And it's a particular pleasure for me to be able to partner in this event with the Texas Department of Banking and a very great honor to be joined by Vice Chairman Bowman with us for today's event. We have all kinds of banks here in the 11th district and represented today at this conference. From large nationwide institutions to community banks that each serve their towns out of a single office. Your banks all make important contributions to our economy. But more than that, the diversity of the banking ecosystem strengthens our economy. Families and businesses can find banks that best meet their needs, whatever those needs may be. Community banks know what makes their towns tick. Growing up in a small town, Versailles, Kentucky, I saw firsthand how community banks serve their neighbors. Meanwhile, larger banks bring the scale and the scope of services that some customers require. And competition drives all banks to find ways to serve the economy better. Promoting a vibrant banking ecosystem is top of mind for me and for all of our team here at the Dallas Fed. Now, the Fed too is a bank. We don't take deposits or make loans to Main Street families and businesses, but as your nation's central bank, we serve the banking needs of commercial banks, which allows you to better serve your customers. Now, when it comes to size, the Fed is at the high end. We are the biggest bank in the country. In fact, with $6.7 trillion in assets, that represents 21% of US GDP. Now, that's down from a post-pandemic peak of 35%. But it's still above the pre-pandemic trough even though the FOMC recently completed the process of normalizing our balance sheet by running off assets that we purchased during the pandemic. The growth of the Fed's balance sheet has prompted a lot of discussion. That's been discussion about whether the balance sheet is too big and if so, how we should shrink it. So today, I'd like to give you my take on those questions. Of course, these are my views and not necessarily those of my FOMC colleagues. So, here's how I see it. With the balance sheet, as with everything the Fed does, the focus needs to be on how we can best serve the public and support a strong economy and financial system. We should use our balance sheet efficiently and effectively to advance those goals. Balance sheet growth isn't bad if it serves the public, but neither should we waste balance sheet space and let it become a distraction from our mission. The minimum size of the Fed's balance sheet is determined by demand for our liabilities, such as currency or bank reserves. We can always offer more liquidity than the economy demands, but if we don't meet the demand, financial pressures will arise. This chart shows the current composition of our liabilities, including about $2.4 trillion in currency, $3 trillion in bank reserves, and approaching $1 trillion in the Treasury General Account, which is the government's checking account. As you can see, currency has trended up smoothly with GDP, but reserves and the Treasury General Account are larger as a share of GDP than before the pandemic. And much larger than before the global financial crisis. In an essay we published this morning, my colleague Sam Schulhofer-Wohl and I examine the Fed's liabilities, how efficiently and effectively they serve the public, and the policy options and trade-offs that would arise in shrinking them. There's a wide range of considerations corresponding to the diversity of ways the balance sheet serves our economy, but I came away from the analysis with a couple of main takeaways and they relate to the Fed liability that's most relevant to you as bankers: bank reserves. Now, before I describe my key takeaways, I want to take a step back and explain how we supply reserves. Since 2008, we have implemented monetary policy with ample reserves. That means we pay interest on reserve balances at close to market rates and we supply enough reserves to meet banks' demand at those rates. When the FOMC changes our monetary policy target, we move market rates to match the new target by changing the interest rate on reserves and other administered rates. Before 2008, we used a different system. That system was scarce reserves. And in that system, reserves earned no interest. We moved market rates by changing the supply of reserves. Market rates were typically hundreds of basis points above zero. The spread made it costly for banks to hold reserves. So, you tried to economize on holding them and hence the name scarce. So, returning to the question of the Fed's balance sheet size, there are two basic ways to reduce the $3 trillion of reserves that the Fed currently supplies. Policymakers could take steps to reduce banks' need for reserves. Then, a smaller quantity of reserves would meet banks' demand with market rates near interest on reserve balances. Our economists would call that shifting the demand curve inward or shifting the demand curve to the left. Now, alternatively, the Fed could return to a scarce reserves regime, and that would mean reducing reserve supply to a level at which market rates meaningfully exceed the interest rate we pay on a bank's marginal dollar of reserves. Economists would call that running up the demand curve. So, this chart compares these two approaches. The chart traces out banks' demand for reserves as a function of interest rates. If we reduce banks' need for reserves so that banks shift the demand curve inward or to the left as in the chart on the left, we're still meeting banks' demand. But if we run up the demand curve, as is shown in the chart on the right and return to scarce reserves, we're pushing up market rates relative to interest on reserve balances and we're putting a price on reserves that banks don't face today. So my first takeaway from our analysis is that shifting the demand curve inward or to the left by reducing banks' need for reserves is a better approach than returning to scarce reserves. US dollar reserves are the safest, most liquid asset in the world. They help banks manage liquidity risk and process payments safely and efficiently. And it costs the Fed little, if anything, to meet banks' reserve demand because the interest we earn on the assets backing reserves matches the interest we pay over time. So overall, the ample reserves framework is efficient and effective. Over nearly two decades now, it has proven its ability to keep money market rates in our FOMC's target range, and it doesn't penalize banks for making smart risk-management decisions by holding the safest, most liquid asset that there is. It would be inefficient to make banks pay a cost, the spread between market rates and the interest on reserve balances, to obtain an asset the Fed can provide so cheaply. Pressing banks to economize on reserves would only increase risk in the financial system. So moving up the demand curve would also present logistical problems and risk undermining the diversity and vibrancy of our banking system. If we stopped paying interest on reserves, banks might try too hard to then again economize that it become difficult to predict reserve demand and control rates. It could also become very costly for banks to meet their legitimate reserve needs and making reserves scarce could gum up the flow of payments. So to avoid these challenges, there have been a number of proposals recently to give every bank a quota on reserves and pay interest only up to that quota. That would stabilize demand. It would help control rates and it would reduce the cost to banks. But quotas are a form of central planning. The government would be allocating a valuable resource among private firms instead of letting the free market speak. And I don't think I need to explain to this audience the drawbacks that could have for innovation, for growth, and for competition. So I favor an approach that reduces banks' need for reserves and shifts the demand curve inward. But my second takeaway is that the precise method of shifting the demand curve inward matters because some methods would be more efficient and effective than others. For example, banks often hold additional reserves to satisfy liquidity regulations or supervisory expectations beyond the reserves they would choose to hold on their own. High-quality regulation and supervision make the banking system safer. In the case of liquidity, supervision and regulation help ensure banks account for the systemic consequences of the liquidity risks that they take like the potential for contagious bank runs. Reserve holdings that make the banking system safer represent an efficient and effective use of our balance sheet and I wouldn't want to discourage that. On the other hand, some liquidity regulations can push banks to hold reserve buffers but then discourage banks from putting those buffers to use in a crisis. Regulations like that might boost reserve holdings without necessarily making the financial system safer. That's an inefficient use of our balance sheet and one we could do without. Vice Chair for Supervision Mickey Bowman recently described options for making liquidity rules more efficient. I look forward to seeing how that work progresses and hearing from her at lunch today. Another way to shift reserve demand inward would be to make the Fed's liquidity tools more accessible. We offer liquidity to banks through the discount window, through intraday credit, and through standing repo operations. If banks are confident they can monetize assets through the Fed when needed, they could choose most of the time to hold fewer reserves and more non-reserve assets such as loans, which are so important to your communities. The Fed has already taken substantial steps to smooth access to these tools. Our discount window direct service lets banks request loans online. We've reduced timelines for completing documentation. And the 12 Federal Reserve banks are working together to simplify the process of pledging and valuing collateral. The New York Fed's trading desk added a second daily standing repo operation to provide funding early in the morning. And the FOMC removed the aggregate cap on standing repo operation usage. The reserve banks are also working with the federal home loan banks to enhance interoperability with the window. Our essay that we published this morning describes a number of additional measures that could further enhance accessibility like central clearing of the standing repo operations or daily discount window auctions. I welcome your ongoing feedback on what more we might do. So, I believe that shifting the demand curve inward through steps like these hold substantial promise for reducing reserves while maintaining the benefits of our ample reserves framework. There are many elements to the Fed's balance sheet beyond those I've mentioned in these remarks and many details to the trade-offs. I want to emphasize that any changes in the balance sheet should be gradual and planned carefully. I hope you'll read the full analysis which is available on the Dallas Fed website. And with that, I'm delighted to turn to my conversation with Robert Hulsey. Robert is CEO of American National Bank in Terrell, Texas, a fifth generation community banker. We're honored to have him on our board of directors. His advice and guidance on the economy, leadership, and our operations, and the importance of community banking enhance our work in so many ways. Now, I focused today on the details of the balance sheet, but I know Robert, and I know he's going to get straight to community banking and the FOMC and our economic policy decisions ahead. So, Robert, I trust you to get us started.

Well, thank you and thank you Robert and I just want to say for all of you in the room, Robert is an incredible champion of community banks. There is not a board of directors meeting that we have where he doesn't remind us of the importance of community banking in your communities and in our economy broadly. And I'm really proud of the work that we've done together. So, thank you and thanks for the opportunity to be here. So, I think all of you know that the FOMC at its last meeting voted to keep interest rates steady. I supported that decision because I thought it was the appropriate path for policy to best balance our dual

Mandate objectives, which all of you know, is maximum employment and price stability. When I was looking at the labor market at the time of the meeting, I saw the labor market that really stabilized in the second half of the year. We had seen some weakness in the labor market in the first half of 2025, and it really started to stabilize over the course of the second half and into the new year. The unemployment rate is standing at 4.4%, which is about where it was in September of last year and about where most economists believe the natural rate is. And in other measures and in conversations with so many of you, I took in information that the labor market was feeling pretty stable. Now, one challenge is that every month we get information on payroll gains in the labor market, and those had been particularly low, and that compares to pretty high levels of monthly payroll growth earlier in the year and in 2023 and 2024. And that just feels uncomfortable given the change in the numbers that we see every month. But it's important to keep in mind there have been significant changes in immigration and in the path of our demographics. And so the level of monthly payroll gains that are needed to keep the unemployment rate steady has dropped quite significantly. And we just put out some research this week on the Dallas Fed website that reestimates that that break-even level for those monthly payroll gains is close to zero. And so that means that there's very little monthly job growth gains that are needed to keep the unemployment rate steady. So my overall sense of the labor market was that it had appeared to have stabilized in the second half of the year. But on the inflation side, even before the conflict in the Middle East, I wasn't convinced that we were headed on a path all the way to our 2% target. In the first readings of inflation earlier in the year, they'd both surprised forecasters to the upside, and I was particularly concerned with looking at the inflation that we were seeing in core services excluding housing, and that to me had just looked really sticky and hadn't changed all that much, which was causing me to be concerned that we weren't headed all the way to 2%. Moreover, we are seeing in the broader economy that business investment is strong. I don't have to tell all of you that because you know that with the growing demands for AI and data centers, particularly here in the 11th district, that business investment is strong, supporting that growth, and the consumers have really been resilient with strong household balance sheets and getting fiscal support coming from refunds in the first part of the year. So the economy was also on solid footing. Financial markets were quite accommodative, and so that's where I was concerned. Now since then we've had the conflict in the Middle East, which has increased our level of uncertainty about the economy and the outlook. It's made our jobs more complex because it's increasing risks on both sides of our mandate.

Well, when I think about just the tremendous amount of uncertainty that's coming from the conflict and I hear from so many of you, I really like to think about how different scenarios might play out. You know, I think one challenge is that multiple times during the year the committee will release our summary of economic projections, which is our outlook for the economy and policy. And I found it pretty challenging this time because you're supposed to put your most likely path when you're giving those figures, and given the uncertainty we have and the various scenarios that could play out, I found it difficult to have a most likely path for the economy because there's just so much we don't know. On the one hand, if the conflict is resolved fairly quickly and we can reopen the Strait of Hormuz, then it's possible that the effects on both the economic activity and the labor market might be pretty moderate. On the other hand, if the conflict continues and it takes quite some time to reopen the strait, then there could be more adverse impacts, and those adverse impacts could be moving in opposite directions with respect to our dual mandate and cause a lot of tension between our responsibilities. So I really like thinking about things in scenarios. Right now I think policy is positioned to adjust to the data as it's coming in, and we're prepared to make adjustments to the policy path as appropriate given the data that comes in and the developments in financial markets more broadly.

Well, I think it's really important to highlight how much we rely on our business and community leaders here in the district on our committees. Just yesterday, Robert was joining me because we had all of our community banks here for our community bank advisory council. We have another committee which we rely on quite a bit, which is an energy council here in the 11th district, and I think some of you have attended that council meeting with us where we have many of the CEOs of both energy companies, both traditional and renewable, who join us, and I rely on them quite a bit for understanding developments. I think one key thing is they've reminded me that as we look across the world in an event like this, the experience of economies vary greatly. You know, with us in the US, we are now a net exporter of energy, and so the position and the effects of a shock like this are different for the US than they have historically and for other countries around the world. So a key question is what the effects are in terms of the US economy, and we're a little bit buffered relative to other economies around the world. Now it's true that with the increase in prices on oil and refined products, consumers are facing higher prices at the pump. You all know that, and that's really challenging for families all across our country. On the other hand, given all of the production of energy here in the 11th district, there are companies that are doing well, earning profits because of these developments. A key question is because of these events, do energy producers invest more capital to create more energy given the higher prices that could potentially offset some of the consequences of a reduction in demand given the hit to consumers. What I've learned from energy executives as I've traveled is that they really need to see these higher prices in a much more sustained way before they would think about investing more capital for more production. We do a survey every quarter. I don't know how many of you have taken a look at our energy survey here in the audience or have read the comments. They can be quite colorful. So if you haven't read them, I would encourage you to do so. But one thing that's in that survey that I think is really valuable is we ask energy producers what's the break-even level that would be required to drill a new, to add a new rig. And that's about $67. So about $67 is what you need to see in oil prices in order to invest. But they need to have a sense that those higher prices are going to stay around for a while. And so I am not hearing that we're going to see a dramatic increase in production here in the short run.

Well, I did have the opportunity to lead the trading desk in New York for many years, and my responsibilities in that role was to implement monetary policy on behalf of the FOMC and to provide guidance and thoughts about developments in financial markets. So, I did spend quite a bit of time with larger financial institutions and understanding capital markets and how they were forming. But I'm really proud of the work that we've done here, and I've had a great opportunity to spend so much time in this role with community banks. We are the state with the largest number of headquartered community banks in the country. And so it's my responsibility to be out there meeting them, understanding them, and really partnering on what makes a difference for our communities all across the district. I loved Emily's note because one of the first things I did in one of our trips is we had to stop at Buc-ee's. So, I got to know what Buc-ee's was here in Texas. The rest of the country should have Buc-ee's. It is incredible. But, you know, we value tremendously the strong partnerships and relationships with all of our community banks. I grew up in a small town in Kentucky. I know exactly what it means to have a vibrant community bank in your community. They sponsored the soccer team I was on when I was young. I remember the name on the back of my jersey, and they really made a difference in providing loans to families and small businesses in that community that really depended on them. In a lot of our rural communities, there just isn't anything else other than that small community bank making a difference. So I really value it. I really love every time I get to be on site with some of our bankers, and I thank you Robert for your leadership all across the state.

Well, I think some of the trends that we're hearing, I think yesterday we talked about this in the community banking advisory council, here in Texas our community banks are doing pretty well. You know, we were looking at the trends in terms of loan activity, in terms of delinquencies and all the statistics that we look at, and the trends that we've been seeing over several years looked pretty stable. And I think that speaks in part to the strong economy that we have here in the 11th district. So overall I think our community banking industry here is doing well, and that's supporting our small businesses all across the district and growth in our communities. And we have communities across our district that are growing at tremendously fast rates given the investment in data centers, LNG facilities, semiconductor plants. So, a lot of growth and the community banks are really important in that, a lot of them providing loans to subcontractors on those larger projects or in developing the amenities for new workers to be able to be there. So I think overall it looks good. That still means we need to be focused on strong risk management, and I know banks are doing that. There's been a lot of experience, we have a lot of experienced bankers in our district who understand the importance of risk management because they've seen the cycles before and they know that even in the good times it's important to maintain that strong risk management. So I think that the issues that we have focused on the agenda, the ones I've been hearing about, fraud, you can't go to a conversation without hearing about fraud, can't go anywhere without hearing about AI and innovation. How are our small community banks going to keep up with the innovation that's taking place in the broader financial system and how do we partner together to make sure people understand what that new innovation is and then how do we make sure those core service providers are really coming along and innovating with them so that you can keep pace with the changes. Those are the issues on my mind. I'd be curious, Robert, is that what you're hearing too or do you think we're missing one of the key themes?

Well, I'm glad we're going to have that panel today on fraud specifically because we need to get the attention of the larger banking institutions. I know that many of you are having a hard time getting focus from them and the panel will be a good chance for us to talk about those issues and see how we can partner to make that happen.

You know, I learn so much from each of the engagements that we have. I think when we're thinking about the economy and about monetary policy, we rely a lot on the data that we collect across the country, but importantly I rely a lot on the surveys that we do because the surveys that we do with you and so many of our leaders across the district is very timely. A lot of the data that we have to look at gets revised over time and can't keep track with the current developments that are taking place in the economy, and so you're giving us that real-time information. I rely on it quite a bit in the work we do. Maybe I could just again put a plug in for being participants in our surveys and just ask how many of you are participating in our regular banking survey that we do every FOMC cycle. Well, it is great to see that we have that many, but there are some hands that aren't up. So, I will make a plug to be a part of that survey. I read all of the comments. I rely on the information and understanding what is happening in credit markets, what we can expect in loan growth and what that's telling us about the overall economy. So, that's really important. The roundtables are really important. And one of the things I'm really proud of the work that Emily and her team have done is making sure they're not only meeting with bankers here or in roundtables, but going to see them where they do their work. I think you can't learn enough about a business unless you're seeing it firsthand. I know Emily and I are doing a visit on site with a bank next week and that's really where you get to understand the business, understand how they're thinking about risks, not in a supervisory capacity but just in getting to know them, getting to know their community and what their strategy is and what the top of mind is for them and their management teams.

Well, I'm a central banker, so you don't sleep. You cannot sleep. There's so many issues top of mind. You know, I would say my primary issue is thinking about the overall health of our economy and making sure that we get the balance between our dual mandate objectives right. And that's really challenging right now because we've been running with inflation above our target for five years now. And it's incredibly important to restore price stability to get inflation back to 2% because stable inflation is just the bedrock for a strong economy. So I think for me that's first and foremost what keeps me up at night and what I know our team needs to be focused on doing great economic analysis so we can make strong and robust decisions at the table.

I've heard from so many of you about how we can modernize the discount window and make sure that it's easy to use. That it's really modernized for the future and that you can move the collateral when you need to use it. My colleagues and I around the Federal Reserve system are focused on that. We've made a number of efforts to ensure that the processes are streamlined, that they're consistent across the country, and that we're focused on issues to modernize it in the future. One key thing is we do have Discount Window Direct now, which does provide some automation. If you're not signed up and using Discount Window Direct, there is a table out in the hallway and I hope you'll stop by so we can work with you to make sure you do have access to Discount Window Direct. And we have a number of initiatives coming on this year to make the full process automated that we're really excited about. I think one key issue that is challenging is the interoperability of collateral between the home loan banks and us. The home loan banks are a really important source of liquidity for all of you, but we need to make sure that you can move that collateral between the home loan banks and us when you most need it. And so we are focused on interoperability. We've done a number of tabletops. We've worked with our home loan bank counterparts. One challenge is that there are multiple home loan banks, and even as we standardize our processes, the home loan banks do things differently and so some of them value each piece of collateral, others take a blanket lien. And that means that our arrangements with each of the home loan banks can be more challenging because they have two different processes that we need to work with. I learned the statistics the other day, which is that there are about 40 different arrangements between reserve banks and home loan banks. So meaning we need to make sure all 40 of those arrangements are smooth, efficient, and effective. Because that's critical for you. So we're focused on that interoperability issue. If there are other issues that are top of mind, please reach out. Email me, call me anytime so we can focus on the issues that are most important to you.

So in our 11th district banking system, it's not one of our top risks that we've identified. But as I look at the financial system more broadly and the economy more broadly, it is an area that we are focused on. There's been tremendous growth in private credit as a lot of activities have moved from the banking system into the non-bank sector. And I think a key issue that Vice Chairman Bowman and other policy makers are focused on is making sure banks are having the appropriate supervision and regulations so that they're doing the lending and there isn't an unlevel playing field between those two. We have seen some weakness and vulnerabilities in private credit as of late, particularly some of the lending that was done in the area of software. We are watching and monitoring that. As I think about broader financial stability issues, I think it's a contained set of vulnerabilities, but it's something that we're paying quite a bit of attention to. When we think about private credit, we tend to think about it having very long lockups so that it can withstand changes in liquidity and valuations. We've seen some redemptions taking place in that area. It's been manageable and is manageable at the moment, but something that we need to keep an eye on.

There's no conversation I have that AI doesn't come up in that conversation with business and community leaders or here at the bank in terms of the work that we're doing. As we look back through history, we know that technology can create incredible opportunities for individuals, create economic growth, improve real wages over time. I think the question is where are we right now with respect to those developments in AI? You know, when I look around the district, I definitely see the investment that's happening in very, very large scale, particularly in data centers, to make the AI capabilities progress, and I see great promise for potential productivity gains from AI in the future. I think those productivity gains are yet to occur. I think we have seen some improvement in productivity in recent years, which has been great for our overall economy. But I think those productivity gains we've seen to date are more about a more efficient labor market coming out of the pandemic and about the innovation that's taking place because of new business formation. I think AI has had a little bit of an effect on those productivity gains so far, but I do think that the greater productivity gains that are coming from AI are still to come and some time out. So right now I'm focused on the investment that's coming to make this new technology productive for us in the future. And that means we have to watch the balance between this increase in demand relative to the supply and ensure that it's not creating inflationary pressures that monetary policy needs to address. So in the near term I'm focused on the increase in demand. But over time I expect there to be stronger productivity gains that come from it, which means that we could have faster growth with lower levels of inflation over time. Really important developments and ones we'll stay focused on.

So the question was about what parallels we might see between subprime developments going into '07 and '08 relative to private credit today. I think one of the strengths of the private credit structures that have been built over time is the long lock-up in capital. Of course, there are gates allowed for some measures of redemptions at periods, but those gates do keep the capital generally locked up. And so the structures are stronger, can see through credit cycles that are quite different than I think we were seeing in some of the structures going into '08. But structures evolve and there's been a lot of growth and there's not always a lot of transparency. So one parallel that I think a lot about is when you see areas in capital markets where there's fast growth and limited transparency, I pay attention and I know we need to be asking a lot of questions and studying those issues hard. That would be the parallel that I would make, is really just given the growth and limited transparency that we really need to be investing, staying close to the issues, hearing from you as bankers, and making sure that we understand the vulnerabilities and how they might spill over into the broader economy.