The discount window lending and other emergency lending programmes from the US Federal Reserve need to be more efficient and effective, said Michelle Bowman, member of the Fed’s board of governors, yesterday. She spoke at a roundtable titled The Lender of Last Resort: The 2023 Banking Crisis and COVID, sponsored by the Committee on Capital Markets Regulation, in Washington, D.C.
The discount window is a central bank lending facility for banks facing short-term liquidity needs when they struggle to borrow from other banks, which is easier as the rate is cheaper and the loans do not require collateral.
However banks have often been reluctant and find it difficult to use. For example, last year Silicon Valley Bank and Signature Bank, both of which failed, were not prepared to use the facility.
“We must understand and evaluate these difficulties and determine whether there are improvements the Federal Reserve System can make to ensure the discount window is an effective tool to provide liquidity support,” Bowman said.
Federal banking agencies have encouraged institutions to be prepared to access discount window loans, but the Fed should also seriously consider whether it should recognise discount window borrowing capacity in its assessment of a firm’s liquidity resources, including in meeting a firm’s obligations under the liquidity coverage ratio, Bowman added.
A long-standing challenge to the utility of discount window borrowing is the perception that only banks in trouble access the facility, according to Bowman. To solve the issue, there have been calls from experts for every bank to pre-position collateral at the Fed.
However, it seems the Fed is unlikely to go down this route. “We do not fully understand the consequences of a new pre-positioning requirement or whether, given the unique nature of SVB’s business model and lax supervision, other institutions would have similarly runnable uninsured deposits, or if this was an idiosyncratic event,” Bowman said.
In particular, pre-positioning of collateral might impede a bank’s ability to manage its day-to-day liquidity needs.
Instead Bowman said the Fed should also look at improving operational and technology issues and extending business hours for the discount window to make life easier for lenders.
In the past the Federal Home Loan Bank has been an important source of liquidity for many banks by providing for overnight loans to keep reserve levels adequate when they have less cash on hand.
However, “the operational design of FHLB advances make these advances poorly suited to function as emergency liquidity support for the banking system,” explained Bowman.
“By contrast, the Fed’s discount window lending authority, and the flexible authority to lend under section 13(3) of the Federal Reserve Act, place the Fed well to function as the lender of last resort in support of banking system liquidity during times of stress.”
Finally, as the non-bank system keeps growing, “what are the implications of more activity occurring outside the banking system as it relates to the effectiveness of the discount window as a tool?”, she asked.
