Banks ‘Pushed’ to Borrow From Fed to Avert Financial Crisis

Lisa DeNell Cook, of Michigan, nominated to be a Member of the Board of Governors of the Federal Reserve System, speaks before a Senate Banking, Housing and Urban Affairs Committee confirmation hearing on Capitol Hill in Washington on Feb. 3, 2022. REUTERS/Ken Cedeno/Pool

The Federal Reserve is continuing to “push” banks to borrow from the central bank to help destigmatize the use of the discount window, Fed Gov. Lisa Cook said at a Brookings Institution event on May 8.

When the Federal Reserve was established in 1913, the discount window was available to struggling financial entities.

For more than a century, the Fed had been considered the lender of last resort.

Typically, the central bank dissuaded banks from tapping the window unless they were on the brink of failure.

Since the regional banking crisis of more than a year ago, the Fed and other financial regulators have discussed establishing a rule forcing banks to borrow from the institution regularly. They say that it would help to reduce the stigma of tapping into the discount window and ensure that they can use it ahead of significant liquidity demand.

Although the draft proposal has yet to be greenlit, officials are talking up the discount window and trying to persuade financial institutions to use the instrument even if they do not need to borrow.

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“We continue to push the discount window,” Ms. Cook said, adding that “efficiencies can be improved.”

While the discount window was performing well during the COVID-19 pandemic and the regional banking crisis, supervisors and regulators are “encouraging banks to pre-position collateral” in case of a downturn.

So far, this initiative has resulted in about $1 trillion being pre-positioned.

According to recent Fed research into discount window readiness, the number of institutions signed up to use the facility totaled 5,418 in 2023, a 9 percent increase from the previous year.

Additionally, the number of entities with collateral pledged was 2,971 last year, 11 percent higher than in 2022.

“The discount window supports the smooth flow of credit to households and businesses and plays an important role in supporting the liquidity and stability of the banking system and the effective implementation of monetary policy,” the Fed Board of Governors said in the report.

“It is important for institutions to maintain a level of operational readiness to borrow from the discount window as part of their contingency funding plans.”

But will the Fed do enough to destigmatize borrowing from the U.S. central bank? A chorus of officials is trying to make the case.

Officials Tout Discount Window Usage

Over the past year, Ms. Cook’s colleagues have repeatedly championed discount window borrowing without a crisis in the background.

In December 2023, Fed Vice Chair for Supervision Michael S. Barr recommended that banks use “the discount window in good times and bad.”

New York Fed President John Williams told a banking group last month that banks must be ready to use the monetary safety net before any trouble arises.

Because many companies were unprepared to tap Fed liquidity, the central bank is attempting to remedy this situation, he noted.

John Williams, CEO of the Federal Reserve Bank of New York, speaks at an event in New York on Nov. 6, 2019. (Carlo Allegri/Reuters)

Speaking shortly after the one-year anniversary of the failures of Silicon Valley Bank and Signature Bank, Fed Gov. Michelle Bowman proposed exploring various avenues “to validate the use of discount window lending in our regulatory framework.”

“While the federal banking agencies have encouraged institutions to be prepared to access discount window loans, we should also seriously consider whether we should finally recognize discount window borrowing capacity in our assessment of a firm’s liquidity resources,” she said at a Committee on Capital Markets Regulation event.

Ms. Bowman agreed that there is a “perception of stigma” surrounding discount window borrowing.

Although she said she does not believe that mandating pledges will be effective, she said the potential shame of borrowing from the lender of last resort can be mitigated by exploring measures that the central bank can employ.

“One of the emerging arguments about how the Federal Reserve can mitigate stigma concerns is simply by mandating that banks pre-position collateral and periodically borrow from the discount window,” the Fed official said.

In May 2023, Dallas Fed President Lorie Logan asserted that traditional stigmas would be eased if financial institutions routinely borrowed from the central bank.

“Periodic borrowing by every bank would make it even more clear that borrowing is not in any way a negative signal,” Ms. Logan told the Texas Bankers Association in prepared remarks.

According to Fed data, nearly 400 depository institutions received more than 800 loans in the first quarter of 2021.

Endorsements and Questions

The proposal has received several endorsements in recent months because it would bolster the industry’s financial stability and increase banks’ liquidity positions.

In January, the Group of Thirty (G30), an international organization of academics, bankers, and economists, published a study supporting “strengthened lender-of-last-resort (LoLR) mechanisms.”

Former New York Fed chief William Dudley, who authored the report, argued that mandating banks to pre-position at the discount window “would enable banks to obtain immediate liquidity in times of stress, avoid fire-selling assets, and shield uninsured depositors from risk.”

Stijn Claessens, project director of the G30 Working Group on the 2023 Banking Crisis and former head of financial stability policy at the Bank for International Settlements, said he believes that this blueprint would be the “most important, most feasible, and lowest-cost reform.”

Susan McLaughlin, an executive fellow at the Yale School of Management, questioned if this could muddy the waters between a well-positioned bank and a struggling institution.

“But is it possible that the combination of a standing facility for adequately capitalized banks with one that is for weaker banks has muddied the waters and created stigma by association?” Ms. McLaughlin asked in an April 2024 paper.

Ultimately, the banking sector is heeding the central bank’s calls, as discount window borrowing recently climbed to its highest level in a year.

“We’re not at crisis levels, but since the [bank term funding program] closed, the ‘lender of last resort’ has been busier than normal,” E.J. Antoni, a Heritage Foundation economist, posted on X, formerly known as Twitter.