The Federal Reserve’s balance sheet sits at roughly $6.7 trillion to $6.8 trillion.

This enormous balance sheet has pushed the Fed into the middle of Treasury markets, report markets, and the banking system itself.

And for Fed chair Kevin Warsh, his mandate is clear: Shrink government involvement and allow the banking markets to do more of the work.

However, this process is far more complicated.

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Kevin Warsh is walking into the Federal Reserve with one of the clearest mandates in years: he wants to shrink the central bank’s footprint.

The Fed’s balance sheet is still sitting around $6.7 trillion to $6.8 trillion, swollen by years of bond buying after the 2008 financial crisis and the pandemic. That balance sheet helped push the Fed into the middle of Treasury markets, repo markets, and the banking system itself.

The goal is to shrink government involvement and let the banking markets do more work. If successful, it could help interest rate cuts become a more powerful tool again.

That said, the process to get there is far messier than others might imagine.

Pursuing this goal will require powerful allies—which Warsh currently has.

Treasury Secretary Scott Bessent and Fed Vice Chair for Supervision Michelle Bowman share the same basic agenda.

They want the Fed to pull back from controlling the lending market, restore interest rates as the main tool for managing the economy, and loosen liquidity rules that keep banks sitting on huge pools of cash.

That last part matters most of all.

The same reserves that make the Fed’s balance sheet so large are also the reserves banks use to satisfy post-2008 liquidity rules.

The Fed’s best tool to shrink its balance sheet is to let bonds roll off its balance sheet. But the issue is, that also removes bank reserves from the system—that in turn hurts how much banks can lend.

Bessent’s team has pointed out that large banks now hold about 25% of their balance sheets in safe assets, up from roughly 10% before the 2008 crisis.

That cash is there for safety. Reserves help banks weather downturns. But the downside is that cash is sitting there not being put to use. Banks are making a choice to keep cash rather than lending.

Basically, the Fed’s involvement is forced to keep its balance sheet large to keep reserves in check. Reforming those rules would let banks hold less idle liquidity and deploy more capital into lending.

Banks don’t like using the Fed’s other liquidity tool, called the “discount window.” The latter is a mechanism through which the central bank can let other banks borrow money for overnight liquidity.

The issue is, the discount window carries stigma. Borrowing from the Fed can make a healthy bank look weak. Bloomberg noted that this stigma is part of what doomed Silicon Valley Bank back in 2023.

That creates another problem for Warsh.

Fed Vice Chair Philip Jefferson oversees the funding windows banks would rely on more heavily in a smaller-reserve system. He has been more cautious than Warsh and his allies. He’s afraid that encouraging banks to use the discount window could force banks to act riskier than they should.

All of this shows that there’s a bit of a deadlock, and it’ll take time for banks to rely on other options, which means the Fed will have to unload its balance sheet slowly.

That is why this process will take years.

It’s fine if this takes years as long as banks keep lending.

Meanwhile, investors should focus on bank lending.

A smaller Fed only helps the economy if capital leaves the central bank’s balance sheet and moves into productive credit.

The early data is encouraging. Commercial and industrial loans at all commercial banks rose from $2.7 trillion in December 2025 to nearly $2.9 trillion in April 2026, according to Federal Reserve Economic Data (“FRED”).

More bank lending can fuel the economy. And arguably, a slow-and-steady approach will help keep the economy afloat for longer than a quick surge in lending.

The next several years should bring a slow decline in reserves, gradual reform of liquidity rules, and continued recovery in bank lending.

Best regards,

Joel Litman & Rob Spivey
Chief Investment Officer &
Director of Research
at Valens Research