A YEAR after Silicon Valley Bank’s failure, less than half of US banks have established borrowing capacity by pledging collateral at the Federal Reserve’s emergency lending facility, according to Fed data released on Friday.

That’s despite a crescendo of calls from financial regulators for banks to make sure they can access the Fed’s discount window quickly if trouble arises. But the data also showed some real progress, with an increase in the number of banks signing up and a jump in the amount of total collateral pledged.

SVB’s inability to access the window in March of last year in the face of massive and rapid withdrawals by its uninsured depositors contributed to the bank’s sudden collapse.

The resulting stress that rippled through the broader banking system revealed a similar lack of preparedness at many of SVB’s peers, and prompted authorities to stand up a separate but temporary lending facility to meet additional liquidity needs. That facility - the Bank Term Funding Programme - ceased loan-making operations last month.

With over US$7 trillion of uninsured deposits in the US banking system, regulators say more banks need ready access to the discount window.

Friday’s data on discount window readiness, the first-ever broad accounting by the Fed of its facility’s reach, show gaps have narrowed, but remain.

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Overall 5,418 banks and credit unions - of a combined total of 9,537 - had the legal agreements in place to borrow from the Fed’s discount window at the end of 2023, up from 4,952 a year earlier, the data show.

The data also show that banks are far more discount-window ready than credit unions. That’s important because on average about 40 per cent of bank deposits are uninsured, making them vulnerable to an SVB-style run; the figure for the typical credit union is less than 3 per cent.

The total value of collateral pledged by banks rose to US$2.63 trillion, from US$1.94 trillion a year earlier, as deposit-taking institutions beefed up their capacity to take out a discount window loan if needed. Credit unions also increased their total pledged collateral, to US$130 billion from US$118 billion.

Even so, the 1,996 banks with pledged collateral at the discount window is less than half the 4,824 total, the data show. A total of 3,900 banks are signed up, leaving as many as 900 banks without any access at all.

“Pre-pledging collateral at the discount window and conducting periodic transactions, including during normal times, greatly facilitates borrowing by institutions on short notice,” the Fed said in the description of its data.

Last-resort lender

Fed officials have indicated they are generally pleased with the state of play.

“We’ve seen a lot of progress,” Fed Vice Chair for Supervision Michael Barr said in late March.

Speaking to Reuters earlier this week, Boston Fed President Susan Collins echoed that sentiment.

“I do think that one of the things we learned a year ago was that some institutions are maybe less prepared than we had realised,” she said. “There was an opportunity there and then there’s been ongoing work to really address that.”

The Fed’s most basic function, more fundamental even than its role as the nation’s chief inflation-fighter and the very reason it was created more than a century ago, is to ensure financial system stability by lending even when no one else will.

Through the discount window, healthy banks can borrow cash in a pinch - not as a bailout funded by taxpayer money, but on the back of banks’ own good, but often less-than-liquid, collateral.

Setting up to do so requires filling out the legal forms - a relatively simple step - and then pledging collateral to create the capacity to borrow, a process that can take weeks as Fed staff value the assets, apply the requisite haircuts - the ‘discount’ - and ensure the central bank has a legal claim should the bank fail to repay the loan.

During the banking sector turmoil last March, borrowers sought a record US$153 billion in emergency loans through the window.

But most of the time, banks are loathe to tap it, for fear of being seen as weak, and because the Fed itself historically discouraged it, in case borrowers actually were weak. A Reuters analysis last year showed smaller banks in particular had little experience with discount window usage, underscoring the broad lack of preparedness.

‘Somebody answers the phone, maybe’

Borrowing from the Fed’s discount window can sound “like the bank is throwing in the towel, and is desperate for liquidity....if the community finds out about it then it can cause stress,” said Independent Community Bankers of America senior regulatory counsel Chris Cole.

Since SVB’s failure, bank examiners increasingly insist banks have access to the discount window, Cole said, citing conversations with member bank CEOs about their recent safety and soundness exams.

But the stigma of it is so ingrained, Cole said, that CEOs are worried about even signing up: “You have to explain to them (the bank’s board of directors) why the examiners are making them do that, that there’s not a liquidity problem at the bank.”

Potential borrowers avoid the discount window for other reasons as well, including the sheer clunkiness.

“You call your regional Fed, somebody answers the phone, maybe,” and then there follows a couple of conversations before a loan can be made, PNC Financial Services CEO William Demchak said at a Brookings Institution event last month.

Some banks may balk at pledging collateral, which depending on the assets may need to be housed at a special audited facility that can take time and money to set up.

And smaller banks and many credit unions may feel they could access any extra cash needs through their relationships with bigger banks, or by borrowing from their local Federal Home Loan Bank.

The FHLBs, like the Fed, lent huge amounts to banks under strain last March.

That may not continue. In a report last November the Federal Housing Finance Agency criticised banks’ use of home loan bank loans to meet liquidity needs rather than tap the Fed, and directed the Home Loan Banks to encourage members to establish borrowing capacity at the Fed’s discount window. REUTERS