A Century-Old Lending Lifeline for Troubled Banks Has a Major Flaw. The Fed Wants to Fix It.
WASHINGTON—After Silicon Valley Bank’s sudden collapse last year, regulators found the California lender was unprepared to borrow from an emergency central-bank facility that might have slowed the firm’s failure.
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The episode is fueling a rethink of the so-called discount window, which dates to the founding of the Federal Reserve in 1913 and is its primary channel for lending directly to banks. At present, banks are desperate to avoid using it for fear of looking weak.
Regulators are now poised to revamp their approach to the facility. They believe requiring banks to be better prepared to tap the “lender of last resort” in a crisis could buy crucial time to help arrest a collapse. SVB failed so abruptly that officials didn’t have time to find a buyer for the ailing lender.
“Even for a bank that is ultimately going to fail, having it happen in a slightly more orderly fashion…that alone is a virtue,” Jeremy Stein, a former Fed governor now at Harvard University, said in a briefing for reporters last month.
Deposit-holding banks can access the discount window for short-term 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 what would be typical for short-term funding. For banks that are teetering, it can be their only option.
After regulators seized Santa Clara, Calif.-based SVB on March 10, 2023, they found that the bank had only a small amount of collateral pledged to the discount window and that it hadn’t done any tests to practice drawing money from the facility.
The bank had been unprepared for a stampede of uninsured depositors, or customers whose balances exceed the standard insurance cap of $250,000—many of them linked to venture capital or tech companies. Its collapse sparked a panic that led to the failure of New York-based Signature Bank two days later. Financial regulators intervened to protect uninsured depositors at both banks. A third bank, First Republic, also experienced a run. It limped along until it was seized and the bulk of it was sold to JPMorgan Chase on May 1.
About a year later, the value of collateral pledged at the window has increased by about $1 trillion to nearly $3 trillion as the Fed presses banks to be better-prepared. Still, only about 2,000 banks have pledged anything to the facility, less than half of the roughly 4,800 U.S. banks. And about 900 haven’t even signed up to borrow, according to the Fed, though most of them are likely small.
Coming rules from the Fed and two other agencies aim to require banks to preposition billions more in collateral. The proposal could require larger banks to have enough cash and posted collateral to be able to borrow the equivalent of a significant portion of their uninsured deposits, perhaps around 40%.
It could also require banks to tap the window a set number of times each year, testing their ability to borrow ahead of any emergency.
The agencies are expected to vote on the proposal as soon as next month. They would have to collect public comment on the measure before approving a final version.
Over time, officials hope the rules chip away at the window’s stigma. They also hope to make the system easier to use. Until last year, banks could only tap the window after a phone call.
“Because the discount window is generally used during periods of stress, there hasn’t historically been the same demand for automation and technological improvements to increase its efficiency in the same way there has been for other financial functions, such as the payments system,” said Jarryd Anderson, co-chair of the financial-services group at the law firm Paul, Weiss, Rifkind, Wharton & Garrison.
The Fed has sought to balance a desire to make the discount window more palatable with transparency requirements. At present, the names of discount-window borrowers are disclosed only after two years, but bankers say the identities of large ones can be guessed from weekly Fed balance-sheet disclosures.
“The day you hit it for anything other than a test you effectively have told the world you failed,” PNC Financial Chief Executive Bill Demchak said at a panel discussion hosted by the Brookings Institution last month.
Steven Kelly, associate director of research at the Yale Program on Financial Stability, said large banks won’t touch the facility until the central bank makes changes to balance-sheet reports to better mask activity in specific Fed districts.
“It’s a really easy fix for the Fed that’s a big deal in the market,” he said.
Write to Andrew Ackerman at andrew.ackerman@wsj.com
