The Fed’s “stigmatized” bank emergency tool attracts negative attention at its own conference.
Reaction on Wall Street
In order to resolve the problems preventing US banks from using a crucial emergency lending facility, the Federal Reserve must take further action.
At a Federal Reserve Bank of Atlanta symposium on May 20, 2024, present and former central bankers and specialists made some incisive remarks directed at the Fed’s efforts to overhaul the backstop program, also known as the discount window.
Participating in a panel discussion, 30-year New York Fed veteran Susan McLaughlin stated, “The discount window is a highly stigmatized financial stability tool.” Although the central bank is attempting to take efforts to make the backstop more effective, McLaughlin, who managed the facility’s operations during the financial crisis, stated that “I think we can go further.”
Banks should feel more at ease utilizing the discount window on a daily basis, according to Fed policymakers and regulators, so that they can react promptly in the event of a financial shock, like a run on deposits. However, banks have been hesitant to use the backstop for fear that doing so would be interpreted as a display of weakness or desperate measures. Its operations are also viewed as cumbersome, outdated, and clumsy by many in the sector.
The quick flight of deposits startled regulators, but they were also taken aback by SVB’s and other companies’ lack of readiness to take advantage of the discount window, forcing them to borrow money from Federal Home Loan Banks, which raises funding costs for everyone.
Michael Barr, the Fed’s vice chair of financial supervision, stated in his keynote address at the Atlanta Fed Conference that in addition to new bank liquidity regulations, regulators are also talking about adjustments that would better equip banks to use the discount window. A portion of uninsured deposits may be used to determine the minimum quantity of easily accessible liquidity that banks exceeding a particular size must keep at the discount window through a pool of reserves and pre-positioned collateral.
In order to encourage the use of the discount window, the Fed Chair Jerome Powell stated in March that there is still “a lot of work to be done” by the central bank, including removing the stigma and making technological advancements.
But according to Bill Nelson, head of research at the Bank Policy Institute, feedback from numerous bank treasurers indicates that the issue is being muddled by regulators’ own guidelines.
Nelson, the former Fed economist, stated, “All of the banks said it has been hammered home to them that borrowing from the discount window is not okay.” “It is ineffective to persuade banks to use the discount window if regulatory measures prohibit them from doing so.”
The Standing Repo Facility, a funding source that allows institutions to borrow money in exchange for Treasury and agency debt at a rate that’s also in line with the top of the central bank’s policy target range, is another funding tool that bank examiners have instructed bank treasurers to not use as part of their internal liquidity stress tests.
According to Nelson, SVB was considering registering for the standing repo facility but changed its mind after learning it couldn’t utilize it to meet its internal liquidity stress-testing requirements. SVB didn’t often use the repo market.
He remarked, “If that were the case, we might be standing here having a very different conversation.” “Instead of a chaotic failure, we would have had an orderly one.”
According to McLaughlin, although banks ought to go to the Fed during difficult times, the stigma associated with the discount window is what makes banks hesitate, which compromises their preparedness in an emergency. It is therefore “neither agile nor effective,” according to her.
In cooperation with a bank’s main regulator, she said the Fed might develop a new framework for supplying liquidity that would include different mechanisms for larger problems like insolvency and others for short-term emergency funding. She mentioned that other nations make a distinction between these roles.
Although banks aren’t currently compelled to register for the discount window, McLaughlin proposed that it might be as part of the procedure for automating collateral inspections and bank chartering.
In order to ensure that every bank is prepared to access the discount window, when necessary, Luc Laeven, director-general of research at the European Central Bank, stated that banks must establish access during regular business hours, become familiar with the regulations, set up collateral arrangements, and test the borrowing procedures.
He declared, “The lender of last resort shouldn’t be like your house keys—carelessly stashed away and impossible to locate in an emergency.” “That isn’t practical in the event of a fire.”