When Brookline Bancorp Inc. needs to borrow short-term cash quickly — part of the regular course of business for the Boston-based lender — it has a range of options. One source of cheap money it’s loath to turn to, however, is the Federal Reserve for fear of setting off alarm bells.
“This is the safety net for the financial system and for individual banks,” said co-president and chief financial officer Carl Carlson. “If you have to use the safety net, that means you missed a rung on the swing and means you needed something.”
“There’s definitely a stigma,” he added.
Policymakers in Washington want to change that. Nearly a century after the Fed first tried to discourage regular borrowing from its traditional backstop program, known as the discount window, officials are trying to rebrand the primary credit facility as a source for everyday liquidity.
That mission has become more urgent in the wake of the collapse of Silicon Valley Bank and other regional lenders in the first half of 2023. Regulators were shocked by the rapid flight of deposits, but also that SVB and others were ill-prepared to even access the discount window, instead relying heavily on borrowings from the Federal Home Loan Banks, which can push up funding costs for everyone.
“Banks need to be ready and willing to use the discount window in good times and bad,” Fed Vice Chair for Supervision Michael Barr said in a Dec. 1 speech.
Now regulators, including the Fed, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp., are drafting a plan to require that banks tap the facility at least once a year, a measure aimed at reducing the stigma for users. That follows guidance from the regulators last year urging institutions to update their contingency funding plans, including for the discount window.
On Capitol Hill, Senator Mark Warner, a Virginia Democrat, has said he’s weighing legislation that would mandate usage of the facility by US banks. And the Federal Housing Finance Agency’s mammoth proposal to overhaul the FHLB system released in November is aimed at driving banks toward more discount-window activity during crises.
While there have been previous attempts to revamp the window, it requires buy-in from every level of the financial system and its overseers, from banks to supervisors, analysts, ratings agencies and market participants that have longed eyed the facility with suspicion.
“The discount window is by definition an emergency instrument and destigmatizing the emergency facility is already a tall order,” said Gennadiy Goldberg, head of US interest rates strategy at TD Securities.
Industry Reluctant
In the Fed’s early years, banks turned to the central bank constantly for “rediscounting,” a practice that allowed them to exchange private debt, such as commercial paper, for dollars.
That changed around the late 1920s as policymakers started to take a dim view of the practice, and required banks to prove that they had a legitimate reason to borrow and had already exhausted private sources of funding. This created the perception that anyone who tapped the discount window must be in trouble, a stain that has dogged the Fed ever since.
Bank of America CEO Brian Moynihan
“Every time, we’re 100% reluctant to use it as an industry because it looks like we’re weak,” Bank of America Corp. chairman and chief executive officer Brian Moynihan said during a Senate hearing last month. “We’ve got to figure out a way to change that.”
The Fed in recent stress periods has created temporary lending programs to entice banks to borrow, including the Bank Term Funding Program launched during the regional bank crisis last year. Banks were happy to take advantage of that program’s attractive terms, and the Fed on Wednesday said it was lifting the rate on loans under the program ahead of its March 11 expiration, after borrowing surged in recent weeks.
Banks “will continue to have ready access to the discount window to meet liquidity needs,” the Fed said in a statement announcing the change.
The central bank overhauled the discount window in 2003 when it established the primary credit facility, where only well-capitalized institutions are able to borrow at a rate above the Fed’s benchmark federal funds rate, and they no longer have to prove that they need the loans. It also created a secondary credit facility for weaker institutions.
Right Incentives
Despite those changes, the stigma around tapping the facility has persisted, said Susan McLaughlin, a 30-year veteran of the New York Fed who oversaw discount window operations during the financial crisis.
McLaughlin, who retired in August, attributed part of the challenge to mixed messaging from the Fed and other regulators about when banks should turn to the facility for funding.
She recalled that bankers said time and again they wouldn’t come to the window, despite the central bank’s encouragement, because they were getting grilled by their supervisors, internal risk committees or senior managers who recalled a prior era when borrowing from the facility was frowned upon.
McLaughlin also said that during her time at the Fed, banks repeatedly indicated that new disclosure requirements under the Dodd-Frank Act were a potential deterrent, even with a two-year lag.
“We in the US need to decide what the discount window is for and act accordingly to create the right incentives to ensure it is effective,” said McLaughlin, who is now an executive fellow at Yale University’s Program on Financial Stability.
She said regulators could better align supervisory practices to reiterate that the discount window is a legitimate source of short-term liquidity when needed, make it easier for banks to apply for access and make it possible for firms to move collateral late in the day if they need it to support their Fed borrowings.
Some have said the Fed should abandon reforms altogether and instead strengthen its Standing Repo Facility, where institutions can borrow cash 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. Yet so far there’s only about 26 counterparties, in addition to the primary dealers, out of the thousands of banks in the US.
“They’re going to have to be very, very focused on making sure its competitive,” said Christopher Whalen, chairman of Whalen Global Advisors, a financial consulting firm, who was also a financial analyst at the New York Fed in the 1980s.
McLaughlin, though, believes it’s still possible to reconsider the design of the discount window so that it becomes a more effective tool to ensure temporary funding disruptions at an otherwise sound bank don’t turn into solvency problems.
“There’s been three stress episodes in the past 15 years,” she said. “We need to be taking a closer look at our lender of last resort toolset.”
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