By David Benoit
Banks have all but abandoned the Federal Reserve's discount
window, and it is straining Wall Street's postcrisis
infrastructure.
Borrowing from the discount window, the Fed's only channel for
lending directly to banks, has plummeted. Through October, banks
are on pace to borrow just $750 million from the Fed this year,
half of last year's total and well below the record low of $940
million set in 1961.
Banks are desperate to avoid the stigma attached to accessing
the window, which is designed to help them weather short-term
funding crunches. It is one reason they are hoarding cash at levels
well above what regulators require, ensuring that they won't be
caught short if markets go awry.
The hoarding has drained liquidity from other parts of the
market, contributing to a cash shortfall that roiled
overnight-lending markets in September. The resulting spike in
rates forced the Fed to inject tens of billions of dollars into the
market for repurchase agreements to stabilize it. Two months later,
the Fed is still pumping money into the repo market.
The ripple effects of the malfunctioning discount window show
how a thicket of postcrisis banking regulation has combined with a
decade of Fed intervention to reshape the financial system's
plumbing in ways even regulators and central bankers struggle to
understand.
JPMorgan Chase & Co., for example, keeps about $120 billion
in reserves at the Fed and won't let it dip below $60 billion on
any given day, Chief Executive James Dimon said at a conference
last month. Doing so gives the bank a big buffer over its
regulatory requirements -- before the crisis, the bank's Fed
balance would routinely slip into negative territory -- but it also
deprives the market of $60 billion in daily liquidity.
"Remember, these were very healthy markets that had that repo
issue," Mr. Dimon said. "In a tough market, that will be harder and
more disruptive."
Deposit-holding banks can access the discount window for
short-term, usually overnight, funding. The loans aren't meant to
be used regularly; rather, they are designed to tide banks over
during cash crunches. To discourage banks from relying too heavily
on the window, the Fed charges a higher interest rate than they
would typically pay for short-term funding.
Before the crisis, banks would occasionally turn to the window
to cover unexpected funding gaps created when, for example, a wire
transfer didn't arrive on schedule. The window helped stabilize
banks and keep money flowing through the system after the Sept. 11,
2001, terrorist attacks and during the financial crisis. In 2008,
when the financial system flirted with disaster, banks borrowed
more than $1.2 trillion from the discount window.
Truly distressed banks can't access the window; borrowers have
to be solvent and post collateral for the loans. But banks have
long feared that a visit to the discount window could raise doubts
about their liquidity and stability, which could spur a run on even
a healthy institution.
While banks largely have been flush with cash in recent years
and haven't especially needed the discount window, the stigma
attached to it has only worsened.
The Dodd-Frank financial overhaul enacted in the aftermath of
the crisis required the names of the banks that borrowed from the
discount window to be disclosed on a two-year lag. Bankers who used
to tap the window say the required disclosures are the biggest
reason they won't do so anymore.
Bank executives are also worried that borrowing money from the
Fed, even on a short-term basis, could look to the public like one
of the widely criticized bailouts of the crisis.
In an August survey, the Fed asked senior bank officials about
the likelihood for their respective institutions using the discount
window. "Very unlikely" was the unanimous answer.
To some extent, their reaction is by design. Regulators have
pushed banks to bulk up on capital so they won't need the
government again. In their living wills -- the plans banks must
file laying out how they will handle severe stress or collapse --
banks can't rely on the discount window to stay afloat. But banks
are keeping far more cash in reserve than regulators require.
"They are managing their liquidity to bring to zero the odds
they ever have to go to the discount window," said Bill Nelson,
chief economist at the Bank Policy Institute who helped rewrite the
discount window rules in 2003 when he worked at the Fed.
In September, a sudden cash shortfall in the repo market sent
the rate for the overnight loans to 10% from just over 2%. The
shock caught the Fed by surprise.
Bankers and regulators have blamed the spike on a shortage of
banking reserves available for borrowing when large payments of
corporate taxes and a sale of Treasurys drained cash from financial
institutions. Banks hit the limits on what they consider to be safe
levels of reserves and stopped lending to the repo markets, sending
rates higher. If banks considered the discount window as an
acceptable source of funding, they may have been willing to part
with more of their excess reserves.
What's more, the rate surge was the kind of stress the discount
window is designed to ease. Yet Fed data indicate no significant
borrowing happened during the September chaos.
The Fed continues to pump money into the repo market on an ad
hoc basis. It also has discussed making the injections more
permanent to give banks a palatable alternative to the discount
window, hoping to spur them to free up some reserves.
Some bankers aren't convinced it would work. Borrowing from the
Fed, even without an interest-rate penalty, conjures too many
memories of the crisis.
"The discount window is option E," said the treasurer of a big
U.S. bank. "This would be maybe option D."
Write to David Benoit at david.benoit@wsj.com
(END) Dow Jones Newswires
November 21, 2019 07:14 ET (12:14 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.