LONDON, Feb 23 (Reuters) - The U.S. Treasury is due to run down a $1.6 trillion bank account at the Federal Reserve as government spending ramps up in the months ahead - a move some analysts warn may crush short-term money rates further and flood financial markets with cash.

The Treasury said recently it would halve its extraordinarily large balance at the so-called Treasury General Account (TGA) by April and cut it to $500 billion by the end of June.

Here's what's involved and its potential fallout:

1/WHAT IS THE TGA AND HOW DOES IT WORK?

The U.S. government runs most of its day-to-day business through the TGA - managed by the New York Fed and into which flow tax receipts and proceeds from the sale of Treasury debt.

When citizens or businesses receives a government cheque, they deposit it at their commercial bank, which presents it to the Fed. The Fed then debits the Treasury's account and credits the bank's account at the Fed - increasing its reserve balance.

The TGA sits on the Fed's balance sheet as a liability, along with notes, coins and bank reserves.

But the Fed's liabilities must match its assets. So a drop in the TGA must see a rise in bank reserves and vice versa. Last year's reserves drain was masked by the Fed's $3 trillion in asset purchases.

But when cash flows leaves the TGA, bank reserves rise - potentially increasing lending or investment in the wider economy or markets.

That's why the government usually keeps TGA balances low. Today's balance is more than four times year ago-levels. In the past four years, it has rarely surpassed $400 billion and prior to 2016, it never exceeded $251 billion.

2/WHY ARE WE TALKING ABOUT TGA NOW?

The TGA balance soared in 2020 because the Treasury ramped up borrowing to pay for an expected $1 trillion-plus in pandemic relief. But as stimulus was approved only in December, the accumulated monies were not all spent.

This year, it plans to run down the balance, slashing first-quarter borrowing plans to a quarter of initial estimates .

That may send what Credit Suisse dubbed a "tsunami" of cash into depositary bank reserves.

What's more, less Treasury borrowing is seen impacting its main funding avenue of recent years - T-bills and cash management bills, cash-like securities banks use as collateral for repo borrowing and hedging derivative trades.

"Fewer bills mean more cash looking for a home in liquidity land," JPMorgan said, adding: "U.S. money market and short term debt market participants are knee deep in liquidity."

3/SO IT'S A MONEY MARKET ISSUE?

Money market imbalances have a habit of spilling over.

Even before the TGA rundown, U.S. banks are awash with cash. The Fed is buying securities worth $120 billion from them each month, aggregate household savings are $1 trillion above pre-COVID levels, and money-market funds are brimming, with assets $700 billion above pre-pandemic levels.

In short, the M2 money supply aggregate is growing at an annual 26% rate.

Citi's global strategist Matt King reckons the rundown of the Treasury's account will effectively triple the amount of bank reserves created by the Fed's asset purchase scheme each month.

He noted a "surfeit of liquidity and a lack of places to put it - hence the rally in short-rates to almost zero, with the risk of their going negative and the complete lack of bids in recent New York Fed repo operations".

One-year and six-month yields have halved since the end of 2020 to six basis points (bps) and four bps respectively - contrasting with rising 10- and 30-year borrowing costs.

Negative yields could see cash flee money market funds for other assets - longer-dated bonds, equities, commodities and so on, further inflating bubble-like markets.

And if relative 'real', inflation-adjusted Treasury yields fall, it could weaken the dollar sharply - meaning that "at the global level the TGA effect will indeed prove highly significant", King added.

4/SHOULD WE WORRY ABOUT ASSET BUBBLES?

Some such as King see clear risks.

Banks too don't always welcome huge reserves. JPM for instance, saw deposit inflows rise 35% year on year in the fourth quarter and fears being slapped with an increase in the minimum capital it's required to hold as a globally systemic bank.

But JPM market strategists say overall liquidity won't much be affected by adding another $1.1 trillion to a system flush with $3.2 trillion in reserves, with effects limited to money markets or short-dated debt.

TD Securities analysts agreed, noting: "Reserves themselves don't translate to equities. What matters for broader markets is QE and fiscal stimulus rather than growth in reserves."

They argue the Fed can address falling T-bill yields or overnight interbank rates by hiking the IOER - the interest it pays banks for holding reserves above the required minimum.

And if Congress does approve President Joe Biden's $1.9 trillion spending plan, Treasury borrowing will rise again, easing the T-bill shortage.

(Reporting by Sujata Rao. Editing by Mike Dolan and Mark Potter)