Banks Are Borrowing More From the Fed: What to Know

Banks are turning to the Federal Reserve’s loan programs to access funding as turmoil sweeps the financial system in the wake several high-profile bank failures.

The collapse of Silicon Valley Bank on March 10 followed by Signature Bank on March 12 prompted depositors to pull their money from some banks and sent the stock prices for financial firms on a roller-coaster ride. The tumult has left some institutions looking for a ready source of cash — either to pay back customers or to make sure they have enough money on hand to weather a rough patch.

That is where the Fed comes in. The central bank was founded in 1913 partly to serve as a backstop to the banking system — it can loan financial institutions money against their assets in a pinch, which can help banks raise cash more quickly than they would be able to if they had to sell those securities on the open market.

But the Fed is now going further than that: Central bankers on March 12 created a program that is lending to banks against their financial assets as if those securities were still worth their original value. Why? As the Fed has raised interest rates to contain inflation over the past year, bonds and mortgage debt that paid lower rate of interest became less valuable.

By lending against the assets at their original price instead of their lower market value, the Fed can insulate banks from having to sell those securities at big losses. That could reassure depositors and stave off bank runs.

Two key programs together lent $163.9 billion this week, according to Fed data released on Wednesday — roughly in line with $164.8 billion a week earlier. That is much higher than normal. The report usually shows banks borrowing less than $10 billion.

Still, there’s a big question looming over both the programs and the entire U.S. economy: Will they be enough to restore confidence in banks? While Treasury and Fed officials have said in recent days that deposit outflows are stabilizing, the answer is not yet clear.

A Little History

Before diving into what those figures mean, it’s important to understand how the Fed’s lending programs work.

The first, and more traditional, is the discount window, affectionately called “disco” by financial wonks. It is the Fed’s original tool: At its founding, the central bank didn’t buy and sell securities as it does today, but it could lend to banks against collateral.

But in the modern era, borrowing from the discount window has been stigmatized. There is a perception in the financial industry that if a big bank taps it, it must be a sign of distress. Borrower identities are released, though it’s on a two-year delay. Its most frequent users are community banks, though some big regional lenders like Bancorp used it in 2020 at the onset of the pandemic. Fed officials have tweaked the program’s terms over the years to try to make it more attractive during times of trouble, but with mixed results.

Enter the Fed’s new facility, which is like the discount window on steroids. Officially called the Bank Term Funding Program, it leverages emergency lending powers that the Fed has had since the Great Depression — ones that the central bank can use in “extraordinary and exigent” circumstances with the sign-off of the Treasury secretary. Through it, the Fed is lending against Treasuries and mortgage-backed securities valued at their original price for up to a year.

Policymakers seem to hope that the program will help reduce interest rate risk in the banking system — the problem of the day — while also getting around the stigma of borrowing from the discount window.

Banks are Borrowing More Than Usual

The backstops seem to be working:  During the recent turmoil, banks are using both programs.

Discount window borrowing climbed to $110.2 billion as of Wednesday, down slightly from $152.9 billion the previous week — when the turmoil started. Those figures are abnormally elevated: Discount window borrowing had stood at just $4.6 billion the week before the tumult began.

The new program also had borrowers. As of Wednesday, banks were borrowing $53.7 billion, according to the Fed data. The previous week, it stood at $11.9 billion. The names of specific borrowers will not be released until 2025.

The Borrowing Could Be a Sign of Trouble

The next issue is perhaps more critical: Analysts are trying to parse whether it is a good thing that banks are turning to these programs, or whether the stepped up borrowing is a sign of financial distress.

“The sharp increase in banks’ emergency borrowing from the Fed’s discount window speaks to the funding and liquidity strains on banks,” analysts at Moody’s wrote after the release of last week’s data.

While Silicon Valley Bank had some obvious weaknesses that regulation experts said were not widely shared across the banking system, its failure has prodded people to look more closely at banks — and depositors have been punishing those with similarities to the failed institutions by withdrawing their cash. PacWest Bancorp has been among the struggling banks. The company said this week that it had borrowed $10.5 billion from the Fed’s discount window.

Or the Borrowing Could Be a Good Sign

The fact that banks feel comfortable using these tools might reassure depositors and financial markets that cash will keep flowing, which might help avert further troubles.

In the past, borrowing from the Fed carried a stigma because it signaled a bank might be in trouble. This time around, the securities the banks hold aren’t at risk of defaulting, they are just worth less in the bond market as a result of the rapid increase in interest rates.

“For me, this is a very different situation to what I have seen in the past,” said Greg Peters, co-chief investment officer at PGIM Fixed Income. “These bonds are underwater because rates are higher but they are not impaired. If you need liquidity you can use them as a source of liquidity through these facilities.”