(Bloomberg) -- The US central bank is exploring adjustments to its liquidity framework, including requirements that would aim to protect uninsured depositors.
The potential rule would seek to guard those deposits without having the government directly guarantee them, according to the Federal Reserve’s chief banking watchdog. It would also look to make the Fed’s principal emergency lending facility, the discount window, more palatable to banks.
Regulators are exploring a requirement that larger banks maintain a minimum amount of readily available liquidity with a “pool of reserves and pre-positioned collateral” at the discount window, based on a fraction of their uninsured deposits, Michael Barr, the Fed’s vice chair for supervision, said in remarks at the New York Fed’s 10th annual US Treasury Market Conference on Thursday.
“It is vital that uninsured depositors have confidence that their funds will be readily available for withdrawal, if needed, and this confidence would be enhanced by a requirement that larger banks have readily available liquidity to meet requests for withdrawal of these deposits,” Barr said. “This requirement would be a complement to existing liquidity regulations,” referring to the Fed’s internal liquidity stress tests and liquidity coverage ratio requirements that banks already face.
Barr said community banks wouldn’t be covered, and regulators would take a “tiered approach” to the requirements, with collateral pre-positioned at the window including both Treasuries and the “full range of assets eligible for pledging at the discount window.”
Fed policymakers and regulators want banks to be more comfortable using the discount window on a regular basis to ensure they can quickly respond in the event of a financial shock that might trigger a run on deposits. Banks, however, have been reluctant to turn to the backstop for fear it would be perceived as a sign of weakness or desperation. Its operations are also seen by many in the industry as clunky, backward and burdensome.
“The problem with stigma in the discount window has been a longstanding one,” Barr said during a question-and-answer session following his remarks. “There have been concerns that using it might be seen as a sign of weakness. We don’t view it that way.”
The mission to overhaul the facility has become more urgent in the wake of last year’s collapse of Silicon Valley Bank and other regional lenders. Regulators were shocked by the rapid flight of deposits, but also that SVB and others were ill-prepared to access the discount window. Instead, they relied on credit from the Federal Home Loan Banks, which can push up funding costs for everyone.
Yellen’s View
Treasury Secretary Janet Yellen, speaking at the same conference, called for “greater supervisory attention on banks with less stable deposits.” She said that includes “making sure that they have diverse sources of contingency funding and especially that they have the capacity to borrow at the discount window and periodically test this capacity.”
Yellen, who oversees the Financial Stability Oversight Council, an inter-agency panel that includes the Fed, also said that “we need regulations that account for unrealized losses on securities.” A key trigger for SVB’s collapse last year was unrealized losses on longer-dated fixed-income securities as interest rates soared.
Barr said the Fed is engaging in ongoing work to improve discount window operations, noting they have added an online portal that allows firms to request and prepay loans in a “more streamlined manner” than was previously possible. The central bank also published a request for information on discount window operations, daylight credit and key components of the functions.
He said progress on improving the discount window has led to greater use. Since the banking crisis of March 2023, Barr said financial firms had pledged more than $1 trillion in additional collateral to the discount window to secure loans from the Fed.
“Given the crucial role of the discount window in providing ready access to liquidity in a wide variety of market conditions, we continuously work to assess and improve its functionality while engaging with current and potential users of the window,” Barr said.
He also noted policymakers are looking at all of their capital rules, including the supplementary leverage ratio. The Fed allowed lenders to load up on Treasuries and reserves without setting aside capital to protect against losses in response to the pandemic, but let the exemptions lapse in 2021.
Barr said the central bank has no plans to change the requirement.
--With assistance from Hannah Levitt, Craig Torres, Jonnelle Marte, Viktoria Dendrinou and Christopher Anstey.
(Updates with additional comments from Barr and Treasury Secretary Janet Yellen beginning in seventh paragraph.)
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