As federal banking regulators consider whether banks that use discount windows should be required to post collateral equivalent to a large percentage of their uninsured deposits, at least one member of the Federal Deposit Insurance Corp. (FDIC) has reservations about the idea.
FDIC Vice Chairman Travis Hill said the proposition, under consideration by the Federal Reserve, “seems dangerous” to him as he described multiple possible changes to bank liquidity and discount window rules while speaking at the American Enterprise Institute in Washington, D.C.
Hill told the audience the Fed is looking into the appropriateness of allowing banks to make electronic discount window funding requests instead of by phone. The agency also is considering extending the window’s hours of operation. Both steps would be necessary, Hill contended, but not enough to address regulators’ concerns about the stability of the financial sector in the wake of last year’s bank failures.
“The Federal Reserve was originally created to mobilize reserves, provide liquidity to banks, and reduce banking panics, with varying success over time,” Hill said. “One prerequisite for this objective to succeed is that banks must be able and willing to use the liquidity facilities available. The lack of use is a multifaceted problem, but the less banks use the discount window in aggregate, the more stigmatizing it is when banks do use it, and the more reluctant supervisors are to allow banks to rely on it as part of their contingency planning.”
The discount window updates would serve “to modernize the discount window’s antiquated operations,” highlighted by stories of Silicon Valley Bank’s “frantic, last-minute efforts to borrow from the discount window” prior to its failure, Hill explained.
“These types of operational improvements seem like a necessary but insufficient step,” he said.
Federal regulators are also mulling over a possible discount window prepositioning rule, inspired by the British economist and former Bank of England Gov. Mervyn King’s proposal he dubbed “Pawnbroker For All Seasons.” King’s proposal would require banks’ cash and central bank borrowing capacity to exceed all runnable liabilities.
“The objective is similar to that of deposit insurance, to remove the risk of runs by removing the risk of loss, but broader (in the sense that it would apply to all short-term liabilities, rather than just a subset of deposits) and leakier (in the sense that it would not completely remove the risk of loss,” Hill said.
Regulators also are considering requiring larger banks to maintain a minimum ratio of cash plus discount window borrowing capacity to uninsured deposits set at some value below 100 percent, Hill explained.
“Whereas a ratio above 100 percent may remove the first mover advantage (at least temporarily), a ratio under 100 percent amplifies it, by shining a magnifying glass on the fact that a bank cannot cover every depositor,” Hill said. “If SVB’s management said to its uninsured depositors on March 8, 2023, ‘Don’t worry, we have 40 percent coverage of our deposits,’ I suspect the reaction from depositors would have been something like, ‘We better make sure we are part of the 40 percent, and not part of the 60 percent!’”
Additionally, Hill touched on the Fed’s plans to encourage banks experiencing funding stress to make more use of available discount window borrowing, adding that the FDIC “may push further” to prohibit the use of brokered deposits in such instances.