What to watch in money markets

INVESTORS are zeroing in on key parts of the market for short-term dollar borrowing to determine if and how signs of systemic stress might be emerging after the biggest US bank collapse in over a decade.

The failure of Silicon Valley Bank has stirred concern additional banks might also be in danger of a funding shortfall. Yet while the stocks of a number of purportedly at-risk firms such as First Republic Bank and Western Alliance Bancorp have taken a record beating and there have been some notable movements in parts of funding markets, the broader system appears to be holding firm for now.

That may change though.

Here are some of the funding-market indicators to look at for potential signs of pressure and areas to be contemplating for possible knock-on effects.

The new backstop

This past weekend saw US authorities introduce a new backstop for banks that Fed officials said was big enough to protect the entire nation's deposits. The Bank Term Funding Program allows banks to monetize their underwater hold-to-maturity portfolio without creating losses because it will provide funding for par value of securities pledged.

Borrowing from the emergency bank facility will be disclosed weekly in the Fed's regular balance sheet update, but individual borrowers won't be named for two years. Usage of the Bank Term Funding Program will be published every Thursday. Money-market watchers and bank investors will be monitoring closely in the coming weeks to see what the take-up is like, and what that might mean for the system.

The facility will offer one-year term funding at 10 basis points over the one-year overnight index swap rate, which, according to Wrightson ICAP, is cheaper than what's offered by Federal Home Loan Banks, another key source of funding for lenders. If banks migrate to the central bank facility, demand for FHLB advances may dwindle. Conversely, it's yet to be seen if participants regard this new facility as having a stigma, despite the relatively advantageous terms it offers.

The discount window

One facility that is often said to carry a stigma is the Fed's so-called discount window. Like the new backstop it offers term funding, but for a shorter period, providing dollars for up to 90 days. Unlike the new facility, the cash that borrowers have historically gotten is less than 100% of the collateral they put up. This so-called haircut is imposed by the Fed to insure itself against risk. As part of its most recent measures, the Fed has also eased terms on the window, although the reputational impact associated with it is likely to persist.

At the end of 2022, balances at the Fed's discount window, normally a last-resort funding source, had already risen to the highest level since June 2020. Combined with an increase in US banks' borrowings through other channels, that suggested the deposit loss was accelerating. Demand did retreat after that, but there's a chance usage has since rebounded on the back of regional bank strains, and all eyes will be on whether that's the case.

Standing repo facility

One other facility the Fed has to provide banks with dollars is its standing repo facility, an outlet that allows approved counterparties to swap Treasuries overnight in exchange for cash. The rub with this facility though is that there are only 16 banks eligible to deal with it, none of which are regional ones. Unsurprisingly, with pressures focused on those smaller lenders, the Fed facility received no bids on Monday.

This facility evolved after bank reserves shrank rapidly during a previous episode of Fed balance-sheet reduction — also known as quantitative tightening. That imbalance in late 2019 sparked upheaval in repo markets and prompted the Fed to restart overnight operations for the first time since the 2008 crisis. Those daily interventions morphed into the SRF, which was officially introduced in July 2021 to prevent short-term rate markets from blowing up.

Some Wall Street strategists were skeptical that such a facility would actually address any strains, and the most recent Senior Financial Officer survey showed SRF was rated the second to least likely to be used, next to the discount window.

Federal home loan bank advances

The Federal Home Loan Banks provide funding to commercial banks and other members via so-called advances. These tend to be short-term loans secured by mortgages or other assets. Banks had little need to resort to this channel while they were flush with cash, but with higher interest rates putting a squeeze on cash, that has shifted. The latest turmoil has the potential to turbocharge that demand.

In a highly unusual move, FHLB banks on Monday tapped the floating-rate note market for an extra US$88,7 billion to bolster their own cash pile, suggesting members are already — or soon will be — clamouring for funding from the institution. That sum came on top of its overnight raising of US$67,55 billion, as well as around US$22,87 billion in term discount notes issued by the institution.

The total amount of advances to members, which is published quarterly, had already more than doubled last year as the Fed sent interest rates spiralling higher and deposit balances came under pressure. They reached US$819 billion at the end of December, above their 2020 pandemic highs, and this latest episode may push them higher still.

Fed funds market

The official data for FHLB advances is, unfortunately, only released quarterly and with a delay, so on a more real-time basis investors can only estimate through proxies.