'The Fed has to keep up': McHenry blasts dated discount window tech

Sarah Silbiger/Bloomberg

The chair of the House Financial Services Committee said the technology behind the Federal Reserve's last resort lending facility is too old to handle 21st century bank runs.

Rep. Patrick McHenry, R-N.C., said the failure of Silicon Valley Bank last March demonstrated not only how banks were ill-equipped to borrow from the Fed's discount window, but also how far the facility's technology had fallen behind the times. 

"On the front side, you have a fast bank run based off consumer tech, which is how we live, yet on the back end, the banks are getting provisions of capital in the way they did in the 1940s," McHenry said Tuesday morning during an event hosted by the Brookings Institution. "It should be done with the push of a button rather than a phone call and it should be done in an instant rather than days."

Reports from the Federal Reserve System and the Federal Deposit Insurance Corp. have noted that staffers at both Santa Clara-based Silicon Valley Bank and New York-based Signature  Bank struggled to access the discount window during their respective bank runs. Neither bank had tested its ability to borrow from the discount window for more than a year, and they lacked the necessary contracts to transfer assets quickly to the Fed as collateral. 

In response to these findings, regulators have made speeches and agencies have issued guidance urging banks to do more to ensure they are discount window-ready. But, McHenry said, such measures would be less arduous if the borrowing process were more "tech-enabled."

"Within minutes, they should be able to have their assets and the discount window linked up and the Fed should know," he said. "We do this all the time in the financial markets. Real world players do this and the Fed has to keep up, but they're a generation behind here, maybe more."

McHenry was one of several speakers to flag the discount window's shortcomings during the one-year look-back at last spring's bank failures.

During a separate panel, Susan McLaughlin, executive fellow of Yale University's Program on Financial Stability, said the discount window likely could not have saved Silicon Valley or Signature from failing, given the deep seated issues on their balance sheets. But, she said, proper borrowing could have slowed the failure process down, buying time for a more orderly resolution and limiting contagion. 

McLaughlin noted that Silicon Valley had not tested its ability to use the discount window in more than a year and Signature had not tested it in more than five years. The latter did not have the discount window as part of its emergency liquidity plan, she said, concluding that the stigma among investors and analysts about banks that use the discount window has been a significant deterrent to bank readiness.

"The window can only be effective if banks are willing to use it when they actually need it," she said.

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William Demchak, chief executive of Pittsburgh-based PNC Bank, said the discount window could serve a critical role in the bank funding space by providing "regular way" lending — giving banks an easily accessible source of liquidity for both day-to-day and emergency needs. 

"It shouldn't be a lender of last resort issue," he said. "It ought to be funding into the banking system that helps in a situation where, for whatever reason, deposits are leaving an institution but there is good collateral and capital that makes that a monetary event as opposed to a critical event." 

But, Demchak noted, the complexity of using the discount window has shifted this role to other entities, such as the Federal Home Loan banks.

"It's incredibly mechanically difficult. Even when you preposition, you have to audit what signature loan is in a vault that's guarded. You call your regional Fed, somebody answers the phone maybe, then they'll have a meeting to see if it's actually OK for you to draw, then they talk to Washington and you draw," he said. "If I draw from the Home Loan bank, I hit a few keystrokes and draw against Treasuries I prepositioned. It's much easier."

Demchak also noted that banks are disincentivized from position assets at the discount window, because those assets are not counted toward liquidity coverage ratio, or LCR, holdings — a mandatory pool of high-quality liquid assets that can be monetized quickly to cover up to 30 days of significant cash outflows. 

"It's crazy for me to preposition collateral and then get penalized for having done so," he said.

McLaughlin agreed that the Fed should revisit its treatment of prepositioned collateral in its LCR calculations, as well as in internal liquidity stress tests. She also called for revisiting the price of borrowing from the discount window, noting that setting the rate of borrowing from the discount window too high could add to the stigma associated with it, while setting it too low could disrupt regular market activity.

McLaughlin also suggested that regular testing of discount window readiness — which regulatory officials have pushed for repeatedly in recent months — should be mandatory rather than voluntary. 

"There's a lot of talk out of the Fed right now, a very good message encouraging banks to use the discount window and use it in their contingency funding plans and to test regularly," she said. "Rather than letting banks decide whether they're going to be ready, let's just require them to be ready."