17-Discount Lesson Window Policies and Section 13(3) of the Federal Reserve
When Banks Borrow From The Discount Window Bank Reserves Increase
Federal Reserve
assets +Discount Loans liabiliies +Reserves
Banking System
assets +Reserves liabiliies +Due to Fed
Eligible Collateral for Discount Window Advances
Margins for Securities (as percentage of Collateral Category
2
estimated fair market value) Duration Buckets 0-5 >5-10 >10 99% 98% 98% 97% 98% 97% 95% 98% 98% 89% 92% 97% 98% 98% 97% 96% 96% 95% 96% 95% 93% 96% 95% 86% 91% 93% 96% 96% 96% 92% 95% 91% 95% 94% 92% 95% 83% 82% 90% 92% 95% 90%
3
Margins for Loans (as percentage of estimated fair market value) Individually Deposited Loans4, 5 Group Deposited Loans4
U.S. Treasuries & Fully Guaranteed Agencies Bill/Notes/Bonds/Inflation Indexed Zero Coupon, STRIPs Bills/Notes/Bonds - U.S. Dollar Denominated Zero Coupon - U.S. Dollar Denominated Government Sponsored Enterprises Bills/Notes/Bonds Corporate Bonds AAA rated - U.S. Dollar Denominated BBB-AA rated - U.S. Dollar Denominated Municipal Bonds U.S. Dollar Denominated Asset Backed Securities AAA rated BBB-AA rated Collateralized Debt Obligations - AAA rated Commercial Mortgage Backed Securities - AAA rated Agency Backed Mortgages Pass Throughs CMOs Commercial Loans & Leases Minimal Risk Rated7 Normal Risk Rated8 Commercial Real Estate Loans Minimal Risk Rated7 Normal Risk Rated8 Consumer Loans - Unsecured Consumer Loans & Leases (auto, boat, etc.) Consumer Loans - Credit Card Receivables Consumer Loans - Subprime Credit Card Receivables Student Loans
87% to 96% 63% to 95% 78% to 96% 57% to 95% 60% to 96% 76% to 96%
87% 63% 78% 57% 60% 76% 59% 54% 83%
Change in Discount Rate Policy
Prior to 2003
Discount Rate was set below Fed Funds rate The Discount rate served as anchor on the Funds rate Banks were forced to borrowed from the discount window, because the provision of nonborrowed reserves was below the demand for combined demand for required and excess reserves There were implicit costs of borrowing from the Fed, and banks were generally reluctant to do so, unless the Fed funds rate was elevated relative to the discount rate The larger the volume of forced discount window borrowing the great the spread between the discount rate and the Funds rate
Total Reserves and Nonborrowed Reserves
Discount Rate Policy Prior to 2003
During times of financial market stress, such as the failure of Continental Illinois in 1984 the implicit costs of borrowing from the Fed became more pronounced. The higher the implicit costs the larger the spread between the Funds rate and the discount rate for a given level of borrowing. The FOMC would establish "Borrowing Objectives", instructing the Open Market Desk to provide nonborrowed reserves in such volumes as to force a particular volume of discount window borrowings In effect the FOMC was attempting to foster a particular spread between the funds rate and the discount rate
The higher the level of Net Borrowed Reserves (borrowed reserves excess reserves), the higher the Funds Rate trades above the Discount Rate
Beginning January 2003 The Discount rate became a penalty rate
The discount rate was set initially 1 percent above the prevailing Fed funds target By having a penalty rate the Fed attempted to remove any implicit costs of borrowing. Banks were no longer discouraged from borrowing at the discount window This new approach to discount window policy was thought of as putting a ceiling on the Fed funds rate
In 2003 the change Fed the way the discount window operates. Henceforth, the discount rate was set as a spread above the FF target...On August 17, 2007 that spread was reduced from 1% to only %, and on March 16, 2008 the spread was reduced to only %.
Cutting the discount rate usually doesn't impact on the funds rate, only if banks are already borrowing heavily from the window
Onset of Current Crisis: Term Funding Rates (1-mo Euro$) exceeded the discount rate early in the crisis
Crisis Related Adjustments to Discount Window Policies
The Fed's first crisis related action was to reduce the spread between the funds rate target and the discount rate from 1% to . 50%. This resulted in a drop in the discount rate from 6-1/4% to 5-3/4%. Later following the the unwinding of Bear Stearns in March 2008 the discount rate spread was reduced to only .25%. Initially the Fed also extended the term of borrowings from overnight to up to 30-days, after Bear Stearns this was increased to 90-days. The intent was to encourage borrowings so that stress in the interbank funding markets would ease Banks still would not go to window because of a perceived stigma
Why a Stigma in borrowing at the discount window?
Banks were concerned that if it became known that they were accessing the discount window they would be perceived as suffering liquidity problems Banks feared depositors might withdraw deposits Banks feared that other creditors, such as banks lending Fed funds, would pull back credit Banks also feared that speculators would "short" their stock, causing a rumor related plunge in their stock price.
Why was the Fed concerned about the lack of borrowing?
The Fed was hoping that the stress in the term interbank funding market would encourage discount window advances, recall the purpose of setting the discount rate above the funds rate was to provide a ceiling on the funds rate, and related interbank financing costs. If banks borrowed from the window the stress in the markets would be relieved.
What Did the Fed Do to Increase Liquidity of Financial Institutions?
Eased Terms at Discount Window Lower Discount/FFR Target Spread, Longer Borrowing Terms Term Auction Facility (TAF)--Instead of banks coming to the window, the Fed auctioned credit. Banks bidding successfully in the auction won credit at costs below market term funding rates Fed opened the Primary Dealer Credit Facility (PDCF) to ensure liquidity to dealers with appropriate collateral Fed activated Currency Swap Lines providing dollar related credit to foreign central banks to enable a relending of these dollars to banks outside the US
Crisis Related Liquidity Provision by the Fed
Under Section 13(3) of the Federal Reserve Act the Fed provided credit to systemically important institutions such as AIG
As the need for crisis related liquidity faded, the Fed began buying longer term securities (some came this Quantitative Easing)
Changing Composition of Fed Assets
Opposite Side of the Fed Coin--Changing Composition of Fed Liabilities
Federal Reserve Balance Sheet - Liabilities
($m s, w ln eekly averag es)
2750000 2500000 2250000 2000000 1750000 1500000 1250000 1000000 750000 500000 250000 03-Jan-07 03-Jul-07 03-Apr-07 0
<---Stage I--->
03-Oct-07 03-Jan-08 03-Apr-08
<Stage II>
03-Oct-08 03-Jan-09 03-Jul-08
<------------Stage III---------->
03-Oct-09 03-Apr-10 03-Apr-09 03-Oct-10 03-Jan-10 03-Jul-09 03-Jul-10
Reserve Balances All Other including FR capital Treasury Deposits (TGA + SFP) Reverse RPs w ith FOI and Dealers FR Notes