Mandating use of the Federal Reserve’s discount window will not ease the stigma of using the program and could create more drawbacks than advantages, said Federal Reserve Gov. Michelle Bowman.
Requiring banks to hold collateral to prepare for potential use of the discount window could make it harder to manage daily liquidity needs while not addressing existing operational and technical shortcomings, Bowman said in prepared remarks for an April 3 roundtable hosted by Washington, D.C.-based research group Committee on Capital Markets.
To Bowman, The Federal Reserve should evaluate improving its technology or extending business hours for the discount window, FedWire and Automated Clearinghouse in times of stress. “We must understand and evaluate these difficulties and determine whether there are improvements the Federal Reserve System can make to ensure the discount window is an effective tool to provide liquidity support,” Bowman added.
Regulators have called on banks to better prepare for potential use of the discount window following the March 2023 failures of Silicon Valley Bank and Signature Bank, after the two banks didn’t use the discount window before failing. Timely discount window borrowing would not have saved the two banks but could have slowed the bank runs and weakened contagion risks, according to the Yale Program on Financial Stability.
Last July, the FDIC, Federal Reserve, Office of the Comptroller of the Currency and National Credit Union Administration advised banks to incorporate the Fed’s discount window into contingency funding plans and ensure sufficient available collateral to cover potential funding needs.
Some banks hesitate to borrow from the discount window out of fear of being perceived as being in a weakened financial position. Research has established banks were willing to pay a premium to avoid using the discount window during the 2007-08 Financial Crisis. In 2020, the Fed lowered the Primary Credit interest rate by 1.5 percentage points to 0.25 percent, which was seen as a way to reduce stigma surrounding the program.
Bowman said two-year public disclosure requirements banks face after accessing the discount window creates additional stigma and could jeopardize public perception of a bank’s financial health. To manage the stigma, Bowman said federal banking agencies should consider recognizing discount window borrowing capacity when assessing liquidity resources.
Regulators must avoid interfering with the decisions of bank managers by requiring industry-wide changes in response to the failure of one institution, she added.
“Is a change of this magnitude, requiring a new daily management of discount window lending capacity, necessary and appropriate for all institutions, or are there particular bank characteristics that may warrant this additional layer of liquidity support?” Bowman said. “These are all important but as yet unanswered questions that need to be explored and understood before imposing such a radical shift.”