Balance Sheet Reduction

Balance sheet reduction means a central bank is shrinking the amount of assets it holds. In simple terms, it happens when the central bank lets its bond holdings decline over time. Balance sheet reduction is important because it can reduce liquidity in the financial system and affect bond supply, yields, and financial conditions. Markets watch it closely when central banks move away from stimulus. For example, if the Fed holds fewer Treasury and mortgage-backed securities over time, its balance sheet is being reduced. Balance sheet reduction is not always sudden. It can happen gradually through scheduled runoff.