Effective immediately, the adjusted interest rate for borrowing will “be no lower” than that of reserve balances in effect on the day the loan is made, the Fed said. — Bloomberg
NEW YORK: The Federal Reserve (Fed) has raised the rate on loans to banks issued under an emergency lending programme launched last year, after borrowing surged in recent weeks as institutions took advantage of the attractive financing terms.
The Fed’s Bank Term Funding Programme (BTFP), unveiled during the regional banking crisis to ease stress in the financial system, will not be extended beyond its March 11 deadline, top officials had signalled earlier this month.
But effective immediately, the adjusted interest rate for borrowing will “be no lower” than that of reserve balances in effect on the day the loan is made, the Fed said.
That rate on reserve balances, which typically moves in tandem with the Fed’s benchmark federal funds rate target, is currently 5.4% – compared with the lending programme’s 4.88%, which is tied to market interest rates.
Those had fallen in recent weeks on expectations of Fed rate cuts.
“This rate adjustment ensures that the BTFP continues to support the goals of the programme in the current interest rate environment,” the central bank said in a statement, adding that no other programme terms had changed.
The BTFP allows banks and credit unions to borrow funds for up to one year, pledging US Treasuries and agency debt as collateral valued at par.
Before Wednesday’s change, the rate for these advances was the one-year overnight index swap rate plus 10 basis points.
Institutions have found it cheaper to borrow cash through the newer facility rather than turning to the discount window, which charges eligible institutions 5.5%.
In fact, banks tapped the window for just US$2.3bil in the week through Jan 17, well off the all-time high of US$153bil in March.
For banks, the drop in BTFP borrowing costs had spelled a larger arbitrage opportunity, one where institutions could borrow from the facility before parking the proceeds in their accounts at the Fed to earn interest on reserve balances.
The change effectively eliminates that opportunity.
Data from the Fed showed a record high US$162bil in borrowing from the BTFP in the week through Wednesday, Jan 17. That compares to the previous all-time high of US$147bil reached the week prior.
The Economist last week called the programme “a free-money machine for banks”.
“It doesn’t surprise me, given the negative press and the very real arbitrage that presented itself,” Steven Kelly, associate director of research at the Yale Programme on Financial Stability, said of the move.
“The Fed doesn’t want to be in the business of printing money in this way for the banks. They’re not going to wait until March,” he added.
Fed officials, including Michael Barr, the Fed’s vice-chair for supervision and New York Fed president John Williams have called the BTFP a response to an “emergency situation” intended to provide liquidity in a pinch.
The agency has long pointed to its discount window as an long-term alternative to such liquidity needs.
“During a period of stress last spring, the BTFP helped assure the stability of the banking system and provide support for the economy,” the Fed said in its release.
“After March 11, banks and other depository institutions will continue to have ready access to the discount window to meet liquidity needs.”
US regulators are preparing to introduce a plan to require that banks tap the Fed’s discount window at least once a year to reduce the stigma and ensure lenders are ready for troubled times. — Bloomberg
