Banks seeking record amount emergency liquidity, Fed reports

U.S. commercial banks are seeking a record amount of emergency liquidity from the central bank over recent days following the collapse of Silicon Valley Bank and Signature Bank, per a report by the Federal Reserve on Thursday.

According to Fed data, as of Wednesday, these banks took out an all-time high of $152.9 billion from the central bank's discount window — the Fed's lending facility meant to assist commercial banks in managing short-term liquidity needs.

At the same time, banks also took out $11.9 billion in loans from the Fed's new Bank Term Lending Program. The total emergency liquidity requested by commercial banks exceeded the $112 billion taken out during the financial crisis in the fall of 2008.

With the addition of over $140 billion in funding provided to take care of the insurance process of SVB and Signature, the Fed's total balance sheet expanded by around $300 billion last week. The increase wiped out a significant portion of the balance sheet reduction the Fed accomplished since the summer of 2022.

Analysts said the news should make the public more confident in the banking system because it showed that the government could still support troubled banks. The borrowing amounts, while significant, did not indicate a "huge system-wide problem."

"The numbers, as we see them right here, are more consistent with the idea that this is just an idiosyncratic issue at a handful of banks," Thomas Simons, a money market economist at investment bank Jefferies, said.

The surge in discount window borrowing is also widely perceived as a positive development. In the past years, banks usually avoided the program for fear of creating volatility in the banking sector by sending a "signal" to the market that the banking system was in trouble. This development shows that the Fed's effort to dispel that stigma is working.

On the other hand, the surge in the Fed's overall balance sheet due to higher borrowing is not in line with its effort to tame inflation. The Fed has been implementing quantitative tightening, which shrinks the central bank's balance sheet, alongside monetary tightening over the past year.

The central bank's move to "inject money" into the market via its lending programs will offset the effect of monetary tightening, several analysts argue. However, some maintained that the effort is a worthy tradeoff to a large-scale bank run that can destabilize the entire economic system.

The Fed's monetary tightening is also under scrutiny for partially influencing the collapse of SVB and Signature. High-interest rates led to difficulty in financing various startups, a major portion of both banks' client base. It prompted customers to withdraw a large amount of money from their accounts, leading to a liquidity issue.

New lending facility

The Fed launched the Bank Term Lending Program on Sunday to manage the possible spillover effect of SVB and Signature's failures last week. This lending facility allows banks and other eligible institutions to borrow against Treasury bills, mortgage-backed securities and other forms of collateral at face value. The Treasury Department provides $25 billion in support for the lending facility via its Exchange Stabilization Fund.

The lending period can extend to a year, with a borrowing cost of the one-year overnight index swap rate plus 10 basis points. It is more lenient than the central bank's lending efforts that put penalties on loans.

Analysts said the expansion of discount window borrowing was "unexpected" because banks were expected to opt for the new program. However, some pointed out that the Fed only established the program after the troubles occurred, and it was likely that commercial banks would soon gravitate toward the new facility.

Yale Program on Financial Stability senior research associate Steven Kelly said the Thursday report had suggested that the establishment of a new lending program might not be necessary. Kelly added that the figures showed that the Fed's discount window was sufficient in managing the recent issue in the banking sector.