As Washington regulators preach
Bankers, politicians, academics and former Fed staffers say the discount window — through which depository institutions can obtain short-term funding in exchange for high-quality collateral — is outdated and ill-equipped for liquidity crises of today.
Last week, Rep. Patrick McHenry, R-N.C., chair of the House Financial Services Committee, equated the process to using "1940s" technology, a nod to the fact that banks initiate the borrowing process by placing a toll-free call to their regional reserve banks.
"It should be the push of a button rather than phone calls, and it should be an instant rather than days," McHenry said during an event hosted by the Brookings Institution. "That piece, [the Fed] didn't fix. This is a question of operational competence."
At that same event, PNC Financial Services Group CEO Bill Demchak called the process "incredibly mechanically difficult," contrasting it with the Federal Home Loan banks, from which banks can secure collateralized short-term funding with "a few keystrokes."
The Fed offers a digitized interface known as Discount Window Direct, through which requests can be made online. Unlike the standard discount window, which closes at 7 p.m. ET weekdays and is closed on the weekends, the online portal is available 24 hours a day. But this option is only available for banks that are eligible for primary credit — meaning they are in sound financial condition — or seasonal credit, which is meant for small institutions with recurring capital needs.
During testimony before the Senate Banking Committee last week, Fed Chair Jerome Powell said the lending facility's functionality is not up to snuff with today's digital banking standards.
"There's a lot of work to do on the discount window," Powell said. "It needs to be brought up technologically into the modern age, we need to eliminate the stigma problem, and we need to make sure banks are actually able to use it when they need to use it. That's a broad work program that we're on right now. It's important."
The discount window has been a focal point for the Fed and other agencies since the bank failures of last spring. In July, the Fed, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency
In his report on the failure of Silicon Valley Bank, Fed Vice Chair for Supervision Michael Barr noted that the Santa Clara, California-based bank did not have sufficient assets prepositioned at the discount window and had not tested its borrowing capabilities in more than a year. While a smoother experience likely would not have saved the bank, which saw $40 billion of deposits withdrawn in a single day, Barr said the episode highlighted the role the discount window can play in protecting financial stability.
"When the system is hit with a shock that results in widespread stress, funding markets are often unable to effectively distribute liquidity," Barr said in an
Still, Barr said the Fed is continuing to study the episode. In a February speech, he indicated that such reflections have included a look back at the Fed's emergency lending practices.
"While banks do their part to get operationally ready, we at the Federal Reserve also need to continue to improve discount window operations," Barr said.
Neither Barr nor Powell elaborated on what those additional steps might look like or when improvements might be rolled out. A Fed spokesperson declined to provide additional context this week.
For banks, their service providers and other policy experts, automation sits atop their wish list for potential changes, something that allows the Fed to draw on the wealth of financial and supervisory information it has about banks to render lending decisions instantaneously.
But such a system could create moral hazards, said David Zaring, a professor of legal studies at the University of Pennsylvania's Wharton School of Business. He notes that the debate about how easy or difficult it should be for commercial banks to borrow from the central banks is as old as the Federal Reserve itself.
While the Fed has an obligation to support banks in moments of distress, Zaring said the Fed also must determine whether a bank is going to fail regardless of whether it intervenes. He added that making such a determination takes time.
"If a bank is insolvent and the Fed has all its high-quality assets as collateral, that means other creditors can't get that collateral, so the Fed might have to worry about insolvent banks loading up on discount window cash even though there's no hope for the future, in a gambling for redemption arc," Zaring said. "That could make the consequences of the ultimate failure more costly."
An overly permissive central bank lending facility could also become a crutch for the banking sector, Zaring said. For this reason, bank supervisors have often chided banks for tapping the discount window and, in turn, such activity tends to draw a negative response from bank directors, shareholders and analysts.
Kevin Messina, a risk management specialist at the consulting firm Baringa and a former supervisor for the Federal Reserve Bank of New York, said one reason the discount window is difficult to use today is because the central bank wanted it to be hard. If the Fed is serious about getting banks to turn to the facility more readily, he said, the institution will have to shift its entire approach toward lending.
"Historically, the Fed didn't want banks to go to the discount window, so they made it difficult to do so," Messina said. "If the Fed really wants banks to use the facility more readily, it needs to do some soul-searching about what the discount window is."
