Mandatory pledges won't fix discount window stigma: Fed's Bowman

As the Federal Reserve works to destigmatize the use of its discount window, one official says mandating use of the emergency lending facility could create more problems than it solves.

In prepared remarks delivered Wednesday morning, Fed Gov. Michelle Bowman questioned whether requiring banks to pledge assets to the discount window and test their borrowing capabilities regularly — moves called for by both current and former regulators in recent months — would actually make banks more willing to use the facility in a pinch.

"The Federal Reserve cannot entirely eliminate discount window borrowing stigma through regulatory fiat," she said.

Bowman delivered her comments during a roundtable discussion of liquidity and regulation hosted by the Committee on Capital Markets, a Washington, D.C.-based research group.

The discussion comes as the Fed, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency focus on liquidity requirements as they look to round out their policy response to the failures of three large banks last spring.

Two of those banks, Silicon Valley Bank and Signature Bank, both failed to borrow from the Fed amid large deposit outflows as staffers struggled to identify eligible assets to pledge as collateral. The consensus among regulators and policy experts is that a smooth discount window experience would not have helped the banks recover from the rapid loss of funds, but it could have bought them time for more orderly dissolutions.

As a result, there has been a growing push in and around Washington to require banks to have enough assets pledged to the discount window to offset deposits that exceed the FDIC's $250,000 insurance cap — the liabilities that are deemed most likely to be pulled out of a bank in a run.

"While this could be an effective approach," Bowman said, "we do not fully understand the consequences of a new pre-positioning requirement or whether, given the unique nature of SVB's business model and lax supervision, other institutions would have similarly runnable uninsured deposits or if this was an idiosyncratic event."

Before instituting such a change, Bowman said, regulators should conduct economic analysis to ensure that such liquidity requirements would not impede banks' day-to-day activities.

Bowman also cautioned against taking a "piecemeal" approach to liquidity reform. Instead, she encourages taking a "broad-based" strategy, one that seeks to "validate the use of discount window lending in our regulatory framework." Specifically, she noted that a bank's discount window borrowing capacity should be included in the calculation of its liquidity coverage ratio.

Last summer, the Fed, FDIC and OCC issued guidance on discount window readiness, and the months that followed have seen Fed Vice Chair for Supervision Michael Barr and other regulatory officials urge banks to ensure they are ready to borrow from the discount window at a moment's notice.

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These efforts appear to have had an effect on how banks are approaching the discount window. In a public appearance last month, Barr said the Fed has seen an additional $1 trillion of assets pledged as collateral to the facility since last spring's failures.

In her remarks, Bowman said she was comfortable with agencies using their supervisory capabilities to push for certain banks — particularly those with larger risk profiles — to make the discount window a bigger part of their liquidity contingency plans. But, she noted, any blanket requirements should be approached carefully.

"While it may be appropriate for supervisors to encourage banks to test contingency funding plans and to evaluate whether those plans are adequate in the context of examination, we must be cautious to not cross the line from supervisor to member of the management team and to avoid interfering with the decision making of bank management by mandating across-the-board changes in response to the  failure of a single unique institution," she said.

Bowman also noted that changes could be made to the discount window's operations, to ensure they function more smoothly. She said such improvements should center on the facility's technical capabilities and hours of operation.

"The Federal Reserve System must also take a close look at our operational readiness and capacity," she said. "Banking stress can manifest quickly and outside of regular business hours in different time zones, and we must make sure that the tools we have are available and prepared with trained and experienced staff ready to deal with the evolving risks of liquidity stress and pressure."

During her remarks, Bowman also addressed shortcomings with the Bank Term Fund Program, an emergency lending facility set up by the Fed under Section 13(3) of the Federal Reserve Act, a provision that allows the central bank — with permission from the Treasury Department — to set up special purpose lending programs during periods of acute stress in the banking sector. 

The BTFP, which went live after the failures of Silicon Valley and Signature, allowed banks to borrow assets — such as Treasurys, agency debt and agency mortgage-backed securities — at their full par value at a very modest interest rate. She said the construction of the facility created a "significant arbitrage opportunity," as banks were able to move assets with paper losses off their books with minimal cost.

"We must learn from this experience," she said. "When we identify flaws in program design or ways to improve our tools in the future, we should avail ourselves of the knowledge we have learned through experience, including by shutting down an authorized section 13(3) facility when it is no longer needed, and lending at a true penalty rate so the usage of the facility naturally declines as market conditions normalize."

The BTFP, which was authorized for one year, was wound down last month.