Gaps in US banks’ safety net
• Emergency borrowing shortfalls
A year after the failure of Silicon Valley Bank (SVB), less than half of US banks have established borrowing capacity by pledging collateral at the Federal Reserve’s emergency lending facility, according to Fed data released on Friday.
That is despite a crescendo of calls from financial regulators for banks to make sure they can access the Fed’s discount window quickly if trouble arises. But the data also showed some real progress, with an increase in the number of banks signing up and a jump in the amount of total collateral pledged.
SVB’s inability to access the window in March 2023 amid huge and rapid withdrawals by uninsured depositors contributed to its sudden collapse. The — stress that rippled through the — broader banking system revealed a similar lack of preparedness at many of SVB’s peers, and prompted authorities to set up a separate but temporary lending facility to meet additional liquidity needs. That facility — the Bank Term Funding Program — ceased loan-making operations last month.
With more than $7-trillion of uninsured deposits in the US banking system, regulators say more banks need ready access to the discount window.
Friday’s data on discount window readiness, the first broad accounting by the Fed of its facility’s reach, shows gaps have narrowed, but remain.
Overall 5,418 banks and credit unions — of a combined total of 9,537 — had the legal agreements in place to borrow from the Fed’s discount window at end-2023, up from 4,952 a year earlier, the data shows.
The data also shows that banks are far more discount window ready than credit unions. That is important because on average about 40% of bank deposits are uninsured, making them vulnerable to an
SVB-style run; the figure for the typical credit union is less than 3%.
The total value of collateral pledged by banks rose to $2.63trillion from $1.94-trillion a year earlier, as deposit-taking institutions beefed up their capacity to take out a discount window loan if needed. Credit unions also increased their total pledged collateral, to $130bn from $118bn.
Yet the 1,996 banks with pledged collateral at the discount window is less than half the 4,824 total, the data shows. A total 3,900 banks are signed up, leaving as many as 900 banks without any access at all.
“Pre-pledging collateral at the discount window and conducting periodic transactions, including during normal times, greatly facilitates borrowing by institutions on short notice,” the Fed said in the description of its data.
Fed officials have indicated they are generally pleased with the state of play.
“We’ve seen a lot of progress,” Fed vice-chair for supervision Michael Barr said in late March.
Boston Fed president Susan Collins echoed that sentiment.
“One of the things we learnt a year ago was that some institutions are maybe less prepared than we had realised,” she said. “There was an opportunity there and then there’s been ongoing work to address that.”
The Fed’s most basic function — more fundamental even than its role as the nation’s chief inflation fighter — and the reason it was created more than a century ago is to ensure financial system stability by lending even when no-one else will.
Through the discount window, healthy banks can borrow cash in a pinch — not as a bailout funded by taxpayer money but on the back of banks’ own good but often less-than-liquid collateral. Setting up to do so requires filling out the legal forms — a simple step — and pledging collateral to create the capacity to borrow, a process that can take weeks as Fed staff value the assets, apply the requisite haircuts — the “discount ”— and ensure the central bank has a legal claim should the bank fail to repay the loan.
During the banking sector turmoil in March 2023, borrowers sought a record $153bn in emergency loans through the window.
But banks are mostly loath to tap it, for fear of being seen as weak, and because the Fed itself historically discouraged it in case borrowers actually were weak. Smaller banks, in particular, had little experience with discount window usage.
Borrowing from the Fed’s discount window can sound “like the bank is throwing in the towel and is desperate for liquidity … if the community finds out about it, it can cause stress,” said Independent Community Bankers of America senior regulatory counsel Chris Cole.
Since SVB’s failure, bank examiners increasingly insist banks have access to the discount window, Cole said, citing conversations with member bank CEOs about their recent safety and soundness exams.
But the stigma is so ingrained, Cole said, that CEOs are worried about even signing up: “You have to explain to them [the bank’s board of directors] why the examiners are making them do that, that there’s not a liquidity problem at the bank.”
Potential borrowers avoid the discount window for other reasons as well, including the sheer clunkiness.
“You call your regional Fed, somebody answers the phone, maybe,” and then there follows a couple of conversations before a loan can be made, PNC Financial Services CEO William Demchak said at a Brookings Institution event last month.
Some banks may balk at pledging collateral, which may need to be housed at a special audited facility that can take time and money to set up.
And smaller banks and many credit unions may feel they could access any extra cash needs through their relationships with bigger banks, or by borrowing from their local Federal Home Loan Bank (FHLB).
The FHLBs, like the Fed, lent huge amounts to banks under strain last March.
That may not continue. In a report in November 2023 the Federal Housing Finance Agency criticised banks’ use of home loan bank loans to meet liquidity needs rather than tap the Fed, and directed the Home Loan Banks to encourage members to establish borrowing capacity at the discount window.
THROUGH THE DISCOUNT WINDOW, HEALTHY BANKS CAN BORROW CASH IN A PINCH — NOT AS A BAILOUT BUT ON THE BACK OF THEIR OWN GOOD BUT OFTEN LESS-THAN-LIQUID COLLATERAL