Fed discount window borrowing continues to rise, but does it pose a problem for the economy?

The Federal Reserve’s key facility for providing bank emergency loans has seen its borrowing rise, reaching over $10 billion recently. Participants in the development market are looking for warning signs that it may signal trouble within the financial system.

At the moment, there are no worries. Many believe that the Fed’s Discount Window is seeing a rise in usage could be a sign of the lifting of stigmatized banks who have been unable to access short-term loans.

However, rising borrowing could indicate trouble in a period when many already worry that Fed rate increases will cause financial system problems. A rising use could indicate that financial sector liquidity may be running low, which could lead to the Fed slowing down or stopping its efforts to reduce the balance sheet.

Although it isn’t a direct line increase, the collective borrowing of deposit-taking banks at the Discount Window has increased since the beginning of the year. It was previously at negligible levels. The week ending Wednesday saw borrowing rise to $7.2 billion. This is just under 3 billion less than the previous Wednesday, when it had reached $10 billion.

The current activity is still a shadow of what it was during stress periods. At the start of the coronavirus epidemic discount window borrowing soared to an all-time high of $50 billion in March 2020. This was still less than the record of $112 billion set in October 2008 during the worst financial crisis.

Analysts say that discount window borrowing is not transparent by design and it can be difficult to draw firm conclusions. The total usage data for the loan is published weekly. However, banks that take out loans have a two year lag. This facility is available to all deposit-taking banks, and also includes small banks.

Thomas Simons from Jefferies is an economist. He said that there shouldn’t be any reason why discount window borrowing has been increasing. He said that the Fed should not be required to provide short-term loans to banks because they are all very cash-rich.

Simons stated that borrowing might rise up to $25 billion or $30 billion by the end of this year without any impact on the financial system’s health. However, if the borrowing rate climbed to $50billion it would “really start to open mine eyes to think that we are entering a time of stress.”

In a Nov. 30 note, Joseph Abate (an analyst at Barclays) stated that the increase in borrowing was strange as it is not economically feasible in comparison to other funding options. The current primary credit rate is 4%. This compares to a range between 3.75% – 4% in federal funds. It also costs more cash borrowed from the discount window that it does in private markets.

Abate stated that the increase in borrowing from discount windows may indicate that there are increasing funding pressures.

Others see the rising use of discount windows in a positive light. This could be a sign that Fed’s long-standing efforts to promote usage and remove stigmatization are paying off.

It’s generally not considered a negative thing. According to Bill Nelson, Chief Economist at the Bank Policy Institute, it’s good because the Fed might be able to reduce stigma. Nelson, a former Fed top staffer was involved in efforts to transform the facility into what it is today.

Since long, the Fed has tried to convince banks that they can use the discount window because it helps with monetary policy and calms markets. The Fed was unable to use this liquidity tool and is now forced to offer other loan facilities. They are worried about being tapped and could be tapped by regulators.

The Fed may also be impacted by rising discount window borrowing, as part of its ongoing effort to reduce its balance sheet. The Fed will not stop taking liquidity from the financial system until it reaches a point that could cause volatile short-term rates of interest.

It could be a sign that reserve shortage is coming sooner than expected if banks face liquidity problems now. This could cause the Fed to stop or slow down reducing its $8.6 trillion current balance.


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