The Federal Reserve’s primary credit program—offered through the “Discount Window” (DW)—provides temporary, short-term financing to essentially sound banks. Historically, loan activity has been low during normal times due to a variety of factors, including the DW’s status as a reserve source of liquidity with a relatively punitive interest rate, the stigma associated with DW borrowing from the central bank, and, since 2008, elevated levels of reserves in the banking system. . However, beginning in 2022, DW’s borrowing under the Basic Credit Program has increased significantly compared to past years. In this post, we examine the factors that may have contributed to this latest trend.
The recent rise in discount window borrowing
After the onset of the COVID pandemic in early 2020, DW’s primary credit borrowing jumped from near-zero levels to a peak balance of about $50 billion in early April of that year, before rapidly ebbing (see chart below). (Note that DW also offers secondary and seasonal credit, lesser-used programs that didn’t see a boom in 2020.) The increase in borrowing has been widespread as small and large banks alike have used DW. Global Systemically Important Domestic Banks (G-SIBs), in particular, have previously announced their intention to borrow from DW to encourage their use during the pandemic. Although they had no need to borrow given their ample reserve balances, the G-SIBs each took out token loans of up to $5 billion for a period of ninety days.
Most SIBs borrowed once near the start of the pandemic, and as their loans matured, loan balances plummeted again. Other banks followed suit and DW loan balances returned to their lowest levels in subsequent months. However, in 2022 there has been a renewed increase in balances, approaching $9 billion in November, as shown in the chart below. While DW’s recent loans are down compared to the early days of the pandemic, they are several multiples greater than they were in the years prior to the pandemic. For example, DW’s loan balances peaked in 2019 at $70 million.
Outstanding discount window loans were low after the pandemic but have increased recently
The rise in DW loan balances began in February of 2022, just before the Federal Reserve began increasing the target range for federal funds rates. Although some observers initially noticed a pattern of increased borrowing around FOMC meetings, this pattern is no longer observed.
What accounts for the recent trend in discount window borrowing?
On March 15, 2020, at the start of the pandemic, the Federal Reserve implemented two policy changes to make the DW Primary Credit Program more attractive to use. First, the DW rate premium for primary credit over the higher end of the federal funds target range was lowered from 50 basis points to zero, ending the punitive cost of borrowing from the DW for market funding sources, or other alternatives such as Federal Home Loan Banks (FHLBs). Second, the maximum duration of the basic credit for one night—the usual limit—was extended to ninety days, with the option to prepay at any time. These policy changes made DW borrowing more economical and flexible, and they are still in effect today.
The significant decrease in the total level of reserves in the banking system this year may be an important factor in the increase in borrowing by DW. In fact, as the Federal Reserve has gradually shrunk its balance sheet, the cash balances of smaller institutions, particularly those with total assets less than $10 billion, have collectively declined sharply relative to the size of their assets, reducing their liquidity positions (see table below). .
The cash balances of small banks have decreased significantly in recent times
The ratio of cash to total assets by the size of the bank’s assets,%
|≤ 3 billion dollars||13.4||8.7||6.8||6.0|
|$3 billion – $10 billion||13.6||9.0||7.3||7.3|
|$10 billion – $50 billion||16.4||17.2||16.3||13.7|
|> $50 billion||17.2||16.7||14.5||14.7|
In addition, smaller banks are generally more willing to come to DW than their larger counterparts, as they are typically not publicly traded companies and are less subject to public scrutiny. As shown in the table below, banks with less than $3 billion in assets visited DW on average twice as many other banks in 2019, just before the pandemic.
Small banks used the discount window more than large banks
|asset range||number of banks||Average days of borrowing|
|≤ 3 billion dollars||189||4|
|$3 billion – $10 billion||29||2|
|$10 billion – $50 billion||17||2|
|> $50 billion||5||2|
Note: Average Borrowing Days is defined as the total number of days each bank borrowed for non-testing purposes aggregated across all banks, then divided by the number of distinct banks that borrowed.
Before the pandemic, small banks came to DW on an ad hoc basis when they needed to borrow overnight to face unexpected funding shortfalls. When anticipating a more permanent need for short-term funds, small banks typically borrow long-term from FHLBs. Because of their limited sophistication, small banks are not active borrowers in the federal funds market.
So far in 2022, small banks generally appear to have continued to rely on FHLB loans for financing needs, with FHLB borrowing up nearly 20 percent to $183 billion from a year earlier, according to the most recent available Contact Report data. But with the elimination of the DW initial credit rate penalty and the availability of DW term loans, DW credit appears to be becoming more competitive with FHLB term advances. This is especially true for the longer-term maturities of sixteen to ninety days that make up nearly half of the DW primary credit loans due in recent months, according to Fed data. As the chart below shows, the three-month FHLB advance rate was 130 basis points higher than the DW primary credit rate, and the one-month FHLB advance rate was 90 basis points higher than the DW rate. (Note that the DW rate is the same for both maturities overnight.) By comparison, before the pandemic, FHLB rates were lower than the DW rate, and in 2021 they are at about the same level as the DW rate.
FHLB prices that have recently risen above the discount window price
In addition to their relatively high rates, regulatory factors may have created an incentive for smaller banks to take out FHLB advances. In particular, a bank must have positive tangible capital to qualify for FHLB loans unless its federal banking agency or insurance company requests the advance in writing. As interest rates rise in 2022, banks have suffered losses in Purchased securities, which is reflected in a decrease in the ratio of tangible capital to total assets. According to Call Report data, that ratio decreased between 2021:Q4 and 2022:Q3, with the smaller banks dropping even more. However, to date only a small subset of banks are seeing negative tangible capital, and these banks account for a negligible share of DW’s borrowing.
The recent increase in DW primary credit borrowing may seem somewhat surprising, given the low and waning usage of DW prior to the pandemic. We suggest that lower rates and longer terms available under the Basic Credit Programme, together with declining reserve balances in the banking system, have all contributed to this trend. It will be interesting to see if this recent pattern of DW borrowing continues in the future or if there is a return to the historical pattern of DW borrowing.
Helen Lee is Director of Capital Markets Trading at the Federal Reserve Markets Group in New York.
Asani Sarkar is a financial research consultant in non-bank financial institution studies in the Research and Statistics Group of the Federal Reserve Bank of New York.
How to cite this post:
Helen Lee and Asani Sarkar, “The Recent Rise in Discount Window Borrowing,” Federal Reserve Bank of New York Liberty Street EconomicsJanuary 17, 2023, https://libertystreeteconomics.newyorkfed.org/2023/01/the-recent-rise-in-discount-window-borrowing/.
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The opinions expressed in this publication are those of the author(s) and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author(s).