Fed's Barr previews mandatory collateral prepositioning, liquidity reforms

Bloomberg News

NEW YORK — Federal Reserve Vice Chair for Supervision Michael Barr said Thursday that the central bank is readying a rule to compel large banks to keep a minimum level of reserves and prepositioned collateral at the Fed's discount window to improve corporate resiliency.

Barr, speaking at the Federal Reserve Bank of New York's 2024 U.S. Treasury Market Conference, said the forthcoming rules would be tailored to be commensurate with a company's size and is meant to ensure that banks that rely on uninsured deposits will be able to meet withdrawal demands in times of stress. 

"It is vital that uninsured depositors have confidence that their funds will be readily available for withdrawal, if needed, and this confidence would be enhanced by a requirement that larger banks have readily available liquidity to meet requests for withdrawal of these deposits," he said. "Incorporating the discount window into a readiness requirement would also reemphasize that supervisors and examiners view use of the discount window as appropriate under both normal and stressed market conditions."

The Fed official said collateral pre-positioned at the window could include Treasury securities as well as a range of assets that the discount window already accepts as collateral. He also said the new discount window requirements would work alongside existing liquidity requirements like liquidity stress tests and the liquidity coverage ratio, which requires large banks to maintain enough high-quality liquid assets to withstand 30 days of significant deposit outflows. He said the coming proposal would exempt smaller community banks. 

Barr has spoken about the importance of the discount window in prior speeches. He noted the Fed recently requested testimony on the discount window operations and daylight credit and said the feedback received would inform future regulatory action. 

"Feedback from the public will help us prioritize areas for improvement, so I strongly encourage anyone with an interest in this topic to weigh in during the comment period," Barr said. "Your feedback will help us ensure that the discount window continues to improve in its role of providing ready access to funding under a variety of market conditions."

Barr also said the Fed is exploring a partial limit on large banks' reliance on held-to-maturity assets in existing liquidity buffers like the LCR and ILST requirements. HTM securities — which banks intend to hold until they mature — lose value as interest rates rise, as they did in the years leading up to 2023. If banks are forced to sell HTM securities before they mature, they could face significant losses. Silicon Valley Bank had to sell HTM securities at a loss to raise liquidity, which wiped out much of the bank's capital and perpetuated a bank run.

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"We saw that banks faced constraints in monetizing HTM assets with large unrealized losses in private markets because they were unable to repo these securities or sell these securities without realizing significant losses," Barr said. "These adjustments would address the known challenges of banks being able to use these assets in stress conditions."

When asked when those reforms would be proposed, Barr said reforms regarding HTM securities at large firms could come as soon as later this year or early next year. 

"We're looking at the appropriate calibration. It's at this time, we haven't made a firm decision about what the right level is," he said. "We're looking at the experience of the last couple of years, we're looking at practices that larger banks currently use … [and] we'd of course put it out as a proposal for public comment and get feedback from the public and affected institutions so I look forward to getting that feedback as part of our process."

The Fed is reviewing the treatment of certain types of deposits in the current liquidity framework — which, in addition to the aforementioned proposals, are aimed at helping large firms ensure liquidity shocks, he said. 

"Observed behavior of different deposit types during times of stress suggests the need to recalibrate deposit outflow assumptions in our rules for certain types of depositors," Barr said. "We are also revisiting the scope of application of our current liquidity framework for large banks."

Banks with at least $250 billion in assets are considered large firms subject to enhanced liquidity measures, but under the current threshold, firms like SVB that saw liquidity stress in 2023 would not be subject to these new rules without a tweak in the framework. Barr is suggesting the Fed may consider expanding the number of banks under such a framework, which would likely encompass mid-sized firms like SVB between $100 billion and $250 billion in assets. 

Banking scholars have recently proposed lowering the asset threshold at which banks are subject to the full liquidity coverage ratio from $250 billion to $100 billion, saying liquidity adjustments could better stave off future calamities than alternative proposals, like raising deposit insurance — something that could only be achieved by an act of Congress. 

Treasury Secretary Janet Yellen — who also spoke at the conference after Barr's remarks — backed many of the reforms Barr outlined. She raised what she saw as the need for stronger supervision of banks with unstable deposits, regulations accounting for unrealized losses on securities, and better preparation for liquidity stress. Yellen also advocated for long-term debt reforms — which have been pending for some time at the main bank regulatory agencies — and enhanced collateral prepositioning at the discount window.

"We also need changes so that banks are better prepared for liquidity stress, such as making sure that they have diverse sources of contingency funding and especially that they have the capacity to borrow at the discount window and periodically test this capacity," she said. "This includes considering establishing collateral prepositioning requirements to facilitate borrowing from the discount window, improving the discount window's operational capacity, and enhancing coordination between the discount window and the Federal Home Loan Banks."