(May 13): The Federal Reserve (Fed) needs to rethink how it provides swift liquidity to banks, a report from the Fed Bank of New York said on Monday.
That’s because despite many years of trying to reform the discount window, the long-standing stigma around this facility “has clearly become deeply engrained among practitioners and it may be impossible to change that norm,” wrote economists Olivier Armantier and Charles Holt. “Even extreme interventions, such as making the [discount window] free, may not be sufficient to fully cure stigma,” they wrote.
The discount window is a Fed facility that exists to provide collateralised loans to deposit-taking banks. While the discount window historically has been thought of as a source of emergency funding, the Fed has changed the terms on the tool to make it more attractive and has encouraged banks to tap it when their respective liquidity is scarce. What’s more, the Fed is currently in a push to make sure banks are signed up and ready to use the discount window.
But in practical experience, reforms have done little to encourage use except in the most drastic of disruptions. The stigma attending the discount window relates to banks fearing that borrowing there, while largely secret, will leak out and send a signal to other banks they’re in trouble, or invite unwanted scrutiny from regulators.
Discount window issues have forced the central bank to stand up emergency lending facilities in times of trouble to bridge the lack of interest in the traditional lender-of-last resort tool.
It did so in the spring of 2023 when several banks ran into trouble and fueled fears of a broader crisis. While discount window use initially jumped on the trouble, it was the central bank’s Bank Term Funding Program, or BTFP, created with the approval and backstop of the Treasury, that did the lion’s share of managing liquidity needs.
The New York Fed paper said facilities like the BTFP — it’s now closed for new borrowing — may be needed in the future. “Temporary facilities could be designed specifically to address the source of the problem at hand,” the researchers wrote. “This is in essence what the Fed has done in recent years when it introduced the Term Auction Facility at the onset of the Global Financial Crisis in December 2007, or the Bank Term Funding Program in March 2023.”
The Fed might also rely more on other liquidity facilities like the Standing Repo Facility, which launched in 2021. That tool allows eligible firms to quickly convert Treasury securities into cash, and while it has been little used thus far, Fed officials see it as a key safety valve for liquidity needs.
“If the Fed intends to protect the Standing Repo Facility against the formation of stigma, it should consider required random borrowing for this facility, not for the [discount window],” the authors wrote, referring to a style of test borrowing that calls for borrowing not driven by need at the time it’s done.
Source: TheEdge - 15 May 2024
Created by edgeinvest | Sep 05, 2024