Banks Are Borrowing More From the Fed: What to Know

Banks Are Borrowing More From the Fed: What to Know

Banks are turning to the Federal Reserve’s lending programs for access to funding as turmoil grips the financial system after several high-profile bank failures.

The collapse of Silicon Valley Bank on March 10, followed by Signature Bank on March 12, prompted savers to withdraw their money from some banks and sent financial company share prices on a rollercoaster ride. The commotion has left some institutions looking for a ready source of cash – either to pay clients back or to ensure they have enough cash on hand to get them through a rough patch.

This is where the Fed comes in. The central bank was created in 1913 to act in part as a backbone for the banking system – it can lend money to financial institutions against their assets in an emergency, which can help banks raise cash faster than they would if they were trading these securities on the open market market would have to sell.

But the Fed is now going even further: central bankers created a program on March 12 that would allow banks to borrow against their financial assets as if those securities were still worth their original value. Why? As the Fed hiked interest rates last year to curb inflation, bonds and mortgage debt that paid lower interest rates fell in value.

By lending the assets at their original price rather than their lower market value, the Fed can protect banks from having to sell these securities at large losses. That could reassure depositors and stave off bank runs.

According to Fed data released Wednesday, two key programs lent a combined $163.9 billion this week — about the same as $164.8 billion a week earlier. This is much higher than normal. The report usually shows banks borrowing less than $10 billion under the Fed’s so-called “discount window” program.

The increased lending underscores a troubling reality: stress continues to pervade the banking system. The question is whether the government’s response, including a new central bank lending program, will be enough to quell them.

Before we delve into the meaning of the new numbers, it’s important to understand how the Fed’s lending programs work.

The first, and more traditional, is the discount window, affectionately known as “disco” by financial professionals. It is the Fed’s original tool: when it was founded, the central bank did not buy and sell securities as it does today, but could lend to banks against collateral.

However, in modern times, borrowing from the discount window has been stigmatized. The prevailing view in the financial industry is that when a big bank taps into it, it must be a sign of distress. Borrowers’ identities are released, albeit with a two-year delay. Its most common users are community banks, although some large regional lenders like Bancorp used it in 2020 at the start of the pandemic. Fed officials have tweaked the program’s terms over the years to make it more attractive in tough times, but with mixed results.

Enter the Fed’s new facility, which is like the steroid discount window. Officially called the Bank Term Funding Program, it uses emergency lending powers the Fed has had since the Great Depression — ones that the central bank can use in “extraordinary and urgent” circumstances with the Treasury Secretary’s approval. This allows the Fed to issue bonds against Treasuries and mortgage-backed securities that are priced at their original price for up to a year.

Policymakers appear to be hoping the program will help reduce interest rate risk in the banking system – the problem of the day – while sidestepping the stigma of borrowing from the discount window.

The backstops seem to be working: During the recent turmoil, banks are using both programs.

Discount window loans rose to $110.2 billion on Wednesday, down slightly from $152.9 billion the previous week – when the turmoil began. Those numbers are unusually high: In the week before the turmoil began, discount window funding was just $4.6 billion.

The new program also had borrowers. Banks borrowed $53.7 billion on Wednesday, according to Fed data. Last week it was $11.9 billion. The names of certain borrowers will not be released until 2025.

The next point is perhaps more critical: Analysts are trying to analyze whether it is a good thing that banks are turning to these programs or whether the increased borrowing is a sign that their problems remain serious.

“There are still some banks that feel the need to tap into these facilities,” said Subadra Rajappa, head of US rates strategy at Société Générale. “There is definitely cash flowing out of the banking sector into other facilities or into the biggest banks.”

While the Silicon Valley Bank had some apparent weaknesses that regulators said weren’t widespread across the banking system, its failures have prompted people to take a closer look at banks — and depositors have penalized those with similarities to the failed institutions, by withdrawing their money. PacWest Bancorp is among the struggling banks. The company announced this week that it had borrowed $10.5 billion from the Fed’s discount window.

The fact that banks are comfortable using these tools could give depositors and financial markets reassurance that money will keep flowing, which could help avert further problems.

In the past, borrowing from the Fed carried a stigma because it signaled that a bank might be in trouble. This time, the securities held by the banks are not at risk of default, they are just worth less on the bond market due to the rapidly rising interest rates.

“For me, this is a very different situation than in the past,” said Greg Peters, co-chief investment officer at PGIM Fixed Income.

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2023-03-23 21:37:12