There’s been an uptick in talk about financial stability from Fed officials in the last few months. This is unsurprising given the concerns about how financial institutions are managing their interest rate risk after the FOMC raised short-term rates by a whopping 525 basis points between March 2022 and July 2023. Further, Fed policymakers are hawkishly reiterating the prospect of another 25 basis point increase at the December 12-13 FOMC meeting and/or the FOMC leaving monetary policy at or nearly as restrictive for some time.
In the wake of the crisis set off by the failure of Silicon Valley Bank in March 2023 and the Fed’s harsh assessment of its failures as a supervisor of the financial system, it is clear that the Federal Reserve is working to prevent another acute episode of stress in the banking sector. Vice Chair for Supervision Michael Barr reflected in a speech on November 16, “The higher rate environment also affected the liability side of banks’ balance sheets. The outflow of bank deposits into money market funds and other alternative short-term instruments, for the most part, has been and remains both anticipated and orderly. Unfortunately, a few firms had a combination of both poor interest rate risk management and weak liquidity risk management. The combination led to failure, as staff documented in my report on Silicon Valley Bank.”
Barr said, “Treasury securities serve as reserve assets for private savers, financial institutions, and other countries. For example, Treasuries comprise a significant portion of banks’ high-quality liquid assets. In times of stress, certain sources of funding can, in some cases, exit quickly. In such cases, access to immediately available liquidity is important, and thus, even in normal circumstances, helps promote safety and soundness. This means that markets for high-quality liquid assets need to be deep and well-functioning in a variety of conditions. Of course, these holdings cannot completely insulate banks from acute risks … but having a readily available liquidity buffer to meet outflows can provide firms with some flexibility to adjust their balance sheets in response to changing market or firm conditions.”
A look at the data for depository institutions in the Fed’s H.4.1 report suggests that primary credit loans – the discount window – have eased considerably after being used extensively in the first weeks after the cascade of failures that started with SVC in March. The same is the case for lending in the other credit extensions category – mainly lending to the FDIC – which made good threatened deposits at the weakest banks. That there is still a need to help financial institutions manage their credit risk is made evident by the rapid and ongoing use of the Bank Term Funding Program established in March 2023 “to support American businesses and households by making additional funding available to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors.” The program offers loans of up to one year to eligible institutions “pledging any collateral eligible for purchase by the Federal Reserve Banks in open market operations”. The collateral includes US Treasuries, US agency securities, and US agency mortgage-backed securities. Importantly, “These assets will be valued at par. The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution’s need to quickly sell those securities in times of stress.”
Use of the funding program means another crisis can likely be avoided, or at least the tools are in place to manage it expeditiously.