June 5, 2023

Great Indian Mutiny

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Banks Borrow More from the Fed: What You Need to Know

Banks are turning to the Federal Reserve’s loan programs for financing as turmoil engulfs the financial system in the wake of several high-profile bank failures.

The collapse of the Silicon Valley Bank on March 10 followed by the Signature Bank on March 12 prompted depositors to withdraw their money from some banks and sent stock prices of financial companies into an accelerating flight. The turmoil has left some organizations looking for a ready source of cash – either to repay customers or to make sure they have enough cash on hand to get through a difficult problem.

This is where the Fed comes in. The central bank was founded in 1913 in part to act as a pillar of the banking system – it could lend money to financial institutions against their assets in case of need, which could help banks raise money faster than they otherwise would. They would be able to do so if they had to sell those securities in the open market.

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

By lending against assets at their original price rather than their lower market value, the Fed can insulate banks from having to sell those securities at a big loss. It could reassure depositors and stave off a run on banks.

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The two major programs together lent $163.9 billion this week, according to Fed data released Wednesday — roughly in line with the previous week’s $164.8 billion. This is much higher than normal. The report usually shows banks borrowing Less than $10 billion In the so-called “discount window” program of the Federal Reserve.

The high lending underscores a troubling truth: stress still runs through the banking system. The question is whether the government’s response, including a new central bank lending program, will be enough to calm that down.

Before delving into what the new numbers mean, it’s important to understand how the Fed’s lending programs work.

The first, and most traditional, is the window sales, affectionately called “disco” by financial pioneers. It’s the Federal Reserve The original toolWhen it was founded, the central bank did not buy and sell securities as it does today, but it could lend to banks against collateral.

However, in modern times, borrowing from the discount window has been stigmatized. There is a perception in the financial industry that if a big bank takes advantage of it, it must be a sign of distress. borrower identities It was released, though two years late. Its most common users are community banks, although some large regional lenders like Bancorp used it in 2020 at the start of the pandemic. Federal Reserve officials have modified the terms of the program over the years to try to make it more attractive in times of turmoil, but with mixed results.

Enter the Federal Reserve New facility, which is similar to the discount window on steroids. Officially called the Term Bank Financing Program, it takes advantage of the emergency lending powers the Fed has enjoyed since the Great Depression — ones that the central bank can use in “extraordinary and urgent” circumstances after approval by the Treasury Secretary. Through it, the Fed lends against Treasury notes and mortgage-backed securities valued at their original price for up to a year.

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Policymakers seem hopeful that the program will help reduce interest rate risk in the banking system — the problem of the day — while also circumventing the stigma of discount window borrowing.

Struts seem to work: During the recent turmoil, banks are using both programs.

discount window Borrowing jumped to $110.2 billion through Wednesday, down slightly from $152.9 billion last week – when the turmoil began. Those numbers are extraordinarily high: discount window borrowing was just $4.6 billion A week ago The commotion began.

The new program also has borrowers. As of Wednesday, banks were borrowing $53.7 billion, according to Fed data. In the previous week, it was $11.9 billion. The names of the selected borrowers will not be released Until 2025.

Perhaps the next issue is more important: Analysts are trying to analyze whether it is a good idea for banks to resort to these programs, or whether the increased borrowing is a sign that their problems are still serious.

“You still have some banks that feel the need to take advantage of these facilities,” said Subhadra Rajappa, head of US interest rate strategy at Société Générale. “There is certainly liquidity moving from the banking sector to other investments, or to the largest banks.”

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

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The fact that banks feel comfortable using these tools may reassure depositors and financial markets that liquidity will continue to flow, which could help avoid further problems.

In the past, borrowing from the Fed carried a stigma because it indicated that the bank might be in trouble. This time, the securities held by the banks are not at risk of default, they are less valuable in the bond market as a result of the rapid increase in interest rates.

“For me, this is a very different situation than I’ve seen in the past,” said Greg Peters, chief investment officer at PGIM Fixed Income.