CRS Identifies Policy Issues Concerning Use of FRB Discount Window by Troubled Banks

The Congressional Research Service ("CRS") identified policy issues concerning the use of the Federal Reserve discount window ("DW") to serve effectively as a lender of last resort.

In an In-Focus Report, CRS reviewed the difficulties that troubled banks encountered when trying to access the DW in 2023. Generally, CRS focused on issues that impede or discourage banks in need of liquidity from pursuing DW advances. These include the following:

• Stigma. CRS highlighted the persistent stigma associated with using the DW since its use may be viewed as a signal to depositors and creditors that the bank is troubled. CRS stated that the stigma may be further exacerbated by mandatory public disclosures of DW borrowing under the Dodd-Frank Act.
• Lending to Failing Banks. CRS said that the DW is designed to support illiquid but not insolvent banks, however, in 2023, three banks that accessed DW loans still failed, highlighting potential shortcomings in the system's ability to restrict DW lending to truly illiquid banks.
• Preparedness by Banks. CRS said that DW loans can be rapidly processed if banks have pre-registered and pre-pledged collateral. The failures of SVB and Signature Bank were precipitated by their difficulties in accessing the DW, largely because they were unprepared and unable to quickly mobilize collateral. CRS stated that Signature Bank tried to pledge ineligible collateral, while SVB struggled with collateral pledging on the day it failed. CRS said that the banks' lack of readiness and familiarity with DW procedures significantly contributed to their downfall.
• Discount Window Modernization. CRS said that SVB and Signature Bank's difficulties in accessing the DW were exacerbated by outdated Fed technology and processes.
• Interaction with FHLB Advances. CRS said that SVB and Signature Bank faced difficulties in transferring collateral from the Federal Home Loan Banks ("FHLBs") to the DW, complicating their borrowing efforts during financial stress. The FHLBs' practices, which include using blanket liens that must be subordinated before collateral can be transferred to the DW, have prompted calls for negotiated agreements to facilitate smoother collateral management between the FHLBs and the Federal Reserve.
• Use by FDIC Bridge Banks. CRS said that in resolving the failures of three banks, the FDIC created bridge banks that assumed existing DW loans, and also secured new loans from the DW, with a total peak borrowing of $228 billion that was fully repaid by November 2023. CRS pointed out that this use of the DW by the FDIC is not explicitly covered by statute, but may have been justified based on bridge banks meeting the criteria for eligible institutions. CRS reported that although the FDIC faced no risk of losses due to collateral and guarantees, the use of the DW instead of traditional funding sources, like the Deposit Insurance Fund or Treasury credit lines, increased the FDIC’s resolution costs by an estimated $2.5 billion, a cost ultimately borne by banks for the benefit of taxpayers.
• Use of Emergency Authority as an Alternative. CRS highlighted that during financial crises, the Federal Reserve established temporary emergency facilities under Section 13(3) of the Federal Reserve Act, which were less restrictive than the traditional DW. This strategy, while circumventing some of DW's limitations and reducing the Fed's profits, increased the risk to taxpayers, but ensured broader utilization among banks.
• Role in Liquidity Requirements. CRS said that current regulations may not fully ensure banks' liquidity in crisis scenarios. Proposals currently under consideration aim to integrate DW access into liquidity calculations, by allowing banks to count their DW borrowing capacity towards meeting liquidity needs, and by requiring banks to pre-pledge collateral based on various risk assessments. CRS cautioned that these proposed changes might lead to higher costs for banks, as they could increase the required holdings of long-term debt and capital, (given that DW loans are discounted,) and allow banks to borrow only a fraction of the pledged collateral's value.