The Federal Reserve is engaged in a full court press to increase banks’ willingness to borrow from the discount window and standing repo facility. Potential benefits of this effort include not only enhanced discount window effectiveness but also reduced bank demand for reserve balances (deposits at Federal Reserve Banks), allowing the Fed to become smaller. The bank failures of spring 2023 demonstrated the importance of banks being ready and able to use the discount window or the standing repo facility as contingency sources of funding. Since then, there have been multiple speeches by Fed officials encouraging banks to use the borrowing facilities, outreach by Fed staff to banks bilaterally, and a “request for information” from the Fed on how to improve the operation of the window.[1] As part of its efforts, the Fed recently issued an FAQ clarifying the rules for the internal liquidity stress tests large banks are required to conduct at least quarterly; the treatment of discount window borrowing in those tests affects bank attitudes toward Fed facilities.
In recent weeks, BPI has conducted a survey of bank treasurers to help gauge the effectiveness of the Fed’s efforts. The survey responses were completed in late November and first half of December. The 31 respondents included GSIBs, regional banks and domestic and foreign banks with large U.S. operations. The questions address: 1) changes in willingness to borrow from the Federal Reserve, 2) changes in demand for reserve balances, 3) strategies for using FHLB advances as a source of contingent funding, and 4) interpretations of the rules for required internal liquidity stress tests. The results, which are summarized here, are encouraging but indicate more work is needed.
In the meantime, the Federal Reserve published its survey of Senior Financial Officers on Friday, which also asked about demand for reserves balances and views of the discount window, but as of September. The SFOS found that most banks’ demand for reserve balances was unchanged or higher. In addition, the SFOS found that most banks were highly unwilling to use the discount window. The results reported here, based on more recent survey, find that a noticeable fraction of banks have become at least somewhat more willing and point to some things that are helping.
In addition, this summer the Fed published an FAQ about ILSTs that allows banks to anticipate using of the discount window or standing repo facility to a greater extent than previously known publicly. Large bank holding companies, those with over $100 billion in assets, are required by regulation to conduct ILSTs over a variety of time horizons, on a quarterly basis, and report the results to their examiners. The tests estimate each bank’s liquidity needs under different scenarios at the overnight, 30-day, 90-day, and one-year horizons. Banks are required to 1) hold highly liquid assets such as reserve balances (deposits at a Federal Reserve Bank), Treasury securities or agency-guaranteed mortgage-backed securities sufficient to meet the projected net cash outflows during those stress scenarios, and 2) show that they can monetize their HLAs (convert the assets into cash). For many banks, ILSTs are their most binding liquidity requirement (i.e., more stringent than other regulatory liquidity requirements).
The FAQ states that banks: 1) can plan on using the discount window or standing repo facility to monetize your HLA, but also that banks must be able to monetize a portion of their HLA in the market and 2) banks cannot include a line of credit (including borrowing capacity at the discount window or FHLB) as a cash flow source that reduces the amount of their net stressed cash-flow need in their 30-day ILSTs.
Section 1: Changes in views on borrowing from the Federal Reserve through the discount window or standing repo facility.
As shown in the summary of responses to questions 1 through 4, the Fed’s efforts are having a favorable effect. As a point of reference, in a previous, smaller, survey, we found that all the respondents were unwilling to borrow from the discount window apart from bridging temporary payment system disruptions. In response to the current survey, one quarter of the treasurers indicated that their bank was more willing to borrow from the discount window than they were a year ago, and one third indicated that they were more willing to borrow from the standing repo facility.
The treasurers pointed to several reasons for their greater willingness. Regarding the discount window, they indicated that the new FAQ was the most important reason, followed by public comments by Federal Reserve officials and then encouragement by supervisors. The banks that were more willing to use the SRF pointed to the FAQ, changed views of senior bank management, and public comments by Fed officials.
Section 2: Demand for reserve balances
Over a third of the respondents indicated that their demand for reserve balances had increased over the past year, while less than 10 percent reported a decrease. Those few banks that reported a decrease pointed to a decline in risk of a substantial immediate demand for funds and to more attractive yields on other liquid assets.
Section 3: Strategy for using FHLB advances as a source of contingent funding.
While most banks indicated that their plans for FHLB advances as a source of contingency funding were unchanged, one quarter indicated that they scaled back their planned use. Several banks indicated the change was largely driven by bank management determinations, public regulator statements, and the March 2023 events.
Section 4: Interpretations of the rules for required internal liquidity stress tests (ILSTs)
The final four questions covered banks’ understandings of the new FAQ. The results suggest that banks have a range of views about what, exactly, the FAQ means.
The first question addressed the meaning of the statement that banks must be able to monetize a portion of their HLA in private markets. The responses were divided among several interpretations. One third of banks judged that the FAQ states that they must be able to monetize some of each type of HLA in their portfolio immediately. One quarter read the FAQ as requiring that they be able to monetize some of each type of HLA over time. A few banks interpreted the FAQ as stating that they must be able to sell or repo some of their HLA, but not necessarily each type of HLA, immediately. Several banks provided different interpretations including that banks must be able to demonstrate that it would have the necessary funds as needed over time.
The final three questions asked the meaning of the FAQ language about ability to anticipate using the discount window, standing repo facility, and FHLBs.
Forty percent of banks concluded that they are not allowed to project inflows from the discount window at any horizon, while one quarter concluded that they are allowed to project such inflows at any time horizon. Two-fifths of banks interpreted the FAQ as stating that they are allowed to project inflows from the discount window for ILSTs of greater than 30 days.
Banks were in somewhat more agreement about what the FAQ indicated about the SRF. Half of the banks concluded that they are allowed to anticipate cash inflows from borrowing from the SRF at any time horizon. Two-fifths of banks concluded that they are allowed to project inflows from the SRF for ILSTs of greater than 30 days. Several banks reached the conclusion that they are not allowed to project inflows at any horizon.
Banks were in greatest agreement about projected use of FHLB advances, perhaps because many banks have been projecting inflows from FHLBs in their ILSTs already. Nearly two-thirds of the banks judge that they are allowed to project inflows from FHLBs for horizons greater than 30 days but not shorter horizons. Still, several banks concluded that they were permitted to project inflows from FHLBs at any time horizon and a few others that they were not permitted to do so at any time horizon.
Conclusion
Given the March 2023 banking stress, it’s no surprise that the Federal Reserve is publicly encouraging banks to be prepared and willing to borrow from the discount window. This is a welcome development and, along with other Federal Reserve efforts including the recent FAQ and discount window RFI, should help improve discount window operations and banks’ operational readiness to borrow when needed. While the stigma associated with borrowing from the Fed remains high, the survey results reported here indicate that the Fed is making some progress – noticeable about a quarter of the banks reported having become at least somewhat more willing to borrow. However, despite these efforts, both the Federal Reserve’s recent survey of senior financial officers and BPI’s Treasurers survey shows that more work needs to be done.
The Fed’s recent FAQ allowing a greater role for the discount window and standing repo facility in banks’ internal liquidity stress test was reportedly the most effective step the Fed has taken to reduce stigma. Despite the FAQ, the survey results indicate that banks still have widely divergent views on the precise rules for the ILSTs. Consequently, the Fed could build on the success of the FAQ by providing even more clarity and encouraging a greater uniformity in the instructions banks are receiving from examiners.
[1] References (https://www.govinfo.gov/content/pkg/FR-2024-09-10/pdf/2024-20418.pdf)
