The US Federal Reserve’s discount window remains underused by banks due to operational issues and a fear of the “stigma” widely associated with the facility, industry experts said at the Atlanta Fed’s Financial Markets conference on Monday.
The discount window is provided by the Fed to enable banks to borrow money on a short-term basis directly from the Federal Reserve, typically to meet short-term liquidity needs.
A stigma surrounds the facility within the industry, partly down to many market players viewing it as “help for a failing bank”, limiting its effectiveness, said Susan McLaughlin, executive fellow of the Yale Program on Financial Stability.
As such, a revised liquidity framework with two distinct tools — a standing facility for routine short-term liquidity to healthy banks and a separate tool for recovery and resolution funding to troubled banks — could reduce stigma and improve the effectiveness of liquidity provision, McLaughlin said.
“Other countries draw a very bright line in their frameworks between these two tools. But in the US, they’re combined under a single discount window [...] that has muddied the waters a bit and has probably contributed to stigma,” she said.
McLaughlin was speaking at a panel discussion on the appropriateness of the Fed’s direct provision of liquidity to stressed sectors, the circumstances under which this is permitted and the role of regulation in reducing liquidity risk.
In a speech earlier in the day, the Fed’s vice-chair Michael Barr said the central bank is exploring a requirement whereby larger banks maintain a minimum amount of readily available liquidity with a pool of reserves and prepositioned collateral at the discount window.
“Incorporating the discount window into a readiness requirement would also re-emphasise that supervisors and examiners view use of the discount window as appropriate and unexceptional under both normal and stressed market conditions,” Barr said.
Luc Laeven, director-general of directorate general research at the European Central Bank, said at the panel discussion that while the stigma surrounding the facility was at times “overdone”, both banks and the Fed must enhance the operational readiness of the discount window for it to be truly effective.
The Fed could consider easing access to liquidity by making the application process lighter and the approval process more automatic, given the “cumbersome” nature of application and approval processes, said Laeven.
“The Fed could consider taking steps to encourage banks to make more regular use of the [discount] window in normal times,” he said, noting that many banks had not used the facility for several years.
To date, discussions about how to make the window more agile and more effective has focused on ensuring that banks are ready to borrow — an “important, but not sufficient condition,” McLaughlin said.
“Banks must not only be ready, but willing to borrow from the [discount] window when they need to, ideally before a run materialises [and] when the central bank can be most effective in mitigating and contagion risk,” McLaughlin added.
The number of banks signed up to use the discount window rose from 3,561 in 2022 to 3,900 in 2023, according to the Fed.
Laeven pointed to comparable facilities provided by the ECB last year during the same period of market stress. “The issue to me is more why this emergency facility was needed. I have yet to see a good analysis of the root cause of [the stigma] and how severe it is,” Laeven said.
Work on the Bank of England’s framework and communication strategy after the collapse of Northern Rock is a “model to live up to”, McLaughlin added, advocating for the Fed to develop and implement a public communications strategy to support a “revised framework for liquidity” and reduce prevailing stigma.
