NY Fed notes that relatively benign factors are driving recent surge in discount window borrowing

NEW YORK, Jan 17 (Reuters) – A recent surge in borrowing at a central bank facility that has a history of providing emergency lending is likely linked to small banks’ liquidity management, the Federal Reserve Bank of New York said in a report on Tuesday .

Fed research took stock of the recent surge in borrowing in the central bank’s discount window that had many analysts scratching their heads.

The facility has long been the institution’s safety valve for deposit-taking institutions that need quick liquidity. For most of its history, the use of discount windows has been seen as a sign of trouble and banks have shunned it, but the Fed has sought to remove the stigma factor in recent years, with uncertain repercussions.

Borrowing on the discount window has increased in recent months, rising from very low levels in early 2022 to a peak of around $10 billion in late November. According to Fed data, usage as of Jan. 11 was just under $4 billion.

All of these recent levels have been shadows of borrowing during recent times of crisis, but they have been higher than recent periods of relative economic calm. The New York Fed noted that in 2019, before the coronavirus pandemic, discount lending peaked that year at just $70 million.

The New York Fed’s report suggested that the surge in borrowing is unlikely to be a sign of trouble. Instead, the bank said in its blog post that the recent jump in the use of discount windows is likely related to smaller banks seeing limited liquidity due to the Fed’s effort to shrink total assets. Also key: Fed actions aimed at bringing the cost of borrowing closer to market levels in the discount window while lending at longer maturities.

“We believe that the lower interest rates and longer maturities available under the primary credit program, along with declining reserve balances in the banking system, have all contributed to this trend,” the report said. “It will be interesting to see if this recent pattern materializes [discount window] borrowing will continue into the future or if there is a return to the historical pattern” of tapping the rebate window.

The report found that smaller banks typically get short-term loans from entities like the Federal Home Loan Banks, and this remains a popular source of liquidity. But changes that result in discount lending at the same level as the federal funds rate, the central bank’s main monetary policy tool, have made it more attractive as a source of funding.

If some banks see reduced liquidity related to the central bank’s ongoing balance sheet reduction efforts, it could have implications for monetary policy. Some analysts already believe the Fed may have to slow or halt efforts this year as changes in the financial system cause liquidity to become tight earlier than expected, threatening the Fed’s control over short-term interest rates.

Reporting by Michael S. Derby; Editing by Andrea Ricci

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