Federal Reserve’s Discount Window: Policy Issues
May 8, 2024
Federal Reserve’s Discount Window: Policy Issues
The failure of three large banks in the spring of 2023 put
be obtained “no questions asked” for any purpose,
the discount window (DW) of the Federal Reserve (Fed)
including “arbitrage opportunities,” such as to lend for
back in the spotlight. DW lending suddenly spiked,
profit. Nevertheless, concerns about stigma remain. Despite
reaching an all-time high of $295.7 billion. This In Focus
official policy, almost 40% of surveyed domestic banks
discusses policy issues raised by this episode. Congress has
said supervisory disapproval made them reluctant to use the
focused on the DW in its oversight capacity, as evidenced
DW. The Fed has promoted the idea that there should be no
by a recent House hearing.
stigma, but it has also tacitly acknowledged that stigma
exists by creating various “untainted” alternative lending
Background
facilities and by convincing large banks to publicly
The Fed was created in 1913 in response to a perceived
announce borrowing from the Fed during crises.
need for a lender of last resort (LOLR). The Fed fills this
role by making short-term loans to depository institutions,
Stigma could be reduced by making DW borrowing
such as commercial banks, through its DW. Typically, the
confidential, which it was until the 2010 Dodd-Frank Act
Fed’s LOLR operations are minimal because banks can
(P.L. 111-203) required the identities and terms of
borrow privately. But during periods of financial instability,
borrowing to be publicly disclosed with a two-year delay.
such as the 2007-2009 financial crisis and the COVID-19
Three-quarters of surveyed banks said these disclosures
pandemic, DW lending grew rapidly as private sources of
discouraged them from using the DW.
liquidity dried up.
Lending to Failing Banks
To borrow from the DW, banks pledge assets as collateral,
Banks can fail because they are illiquid (they cannot access
temporarily converting illiquid assets into liquid reserves.
cash) or insolvent (their assets are worth less than their
Banks that are adequately capitalized and are not poorly
liabilities). The DW is meant to protect illiquid—not
rated by their supervisors use primary credit and can
insolvent—banks, which arguably did not occur in 2023, as
borrow for up to 90 days with “no questions asked.” Poorly
three banks borrowed from the DW and failed anyway.
capitalized or rated banks must use secondary credit, which
is shorter term and subject to close oversight. Seasonal
DW lending to problem banks is meant to be limited
credit is also available for small banks to manage seasonal
because they may use it to “gamble for resurrection.” Yet
inflows and outflows. The Fed sets the discount rate
the three large banks that failed in 2023 remained eligible
charged for loans. Traditionally the primary credit rate was
for primary credit until shortly before their failures. Post-
set above market rates, but since the pandemic it has been
mortem regulator reports found that examiners did not
set at the top of the federal funds rate target range. The
downgrade them as quickly as they should have: All three
secondary credit rate is still higher. In addition to the limits
were considered well capitalized by regulatory standards
on secondary credit, risks to the Fed are minimal because
until they failed. Although Silicon Valley Bank (SVB) and
loans are short term, must be repaid even if collateral loses
Signature failed very suddenly and unexpectedly, First
value, and are backed by assets worth more than loan value.
Republic’s failure was more drawn out, and it was able to
borrow $109 billion through primary credit after
Policy Issues
experiencing depositor runs that made its weakness a high-
profile story. It remained eligible for primary credit until
Stigma
three days before its failure when the FDIC downgraded its
An effective LOLR is one where banks do not use the DW
supervisory rating.
in normal conditions and readily use it in times of financial
stress. Although DW lending has ramped up in crises,
Although all DW loans to the failed banks were fully
policymakers express concern that stigma associated with
repaid, the episode nevertheless raises concerns about the
the DW reduces its use. Stigma may create reluctance to
effectiveness of limitations on lending to failing banks. It is
borrow from the DW because depositors or other creditors
unclear whether the loans increased or reduced risk to the
will view this as a signal that the bank is troubled and run
taxpayer, notably in the case of First Republic. DW lending
on the bank—a fear that is most likely to manifest during
might have delayed its inevitable failure, and resolving
stress periods when usage is desired. If true, stigma makes
banks at least cost typically requires a failing bank to be
the DW less effective at mitigating systemic risk.
resolved as soon as possible. Alternatively, DW loans may
have reduced costs by allowing for its more orderly
The Fed discouraged DW use in normal conditions until
resolution, in contrast to SVB and Signature, which
2003, when it reformed DW operations partly to reduce
required emergency guarantees of uninsured deposits.
stigma by removing moral suasion and by making loan
approval easier. The Fed now states that primary credit can
https://crsreports.congress.gov
Federal Reserve’s Discount Window: Policy Issues
Preparedness by Banks
FHLBs’ regulator has called for them to negotiate
DW loans can be made quickly if banks have signed up and
agreements with the Fed to ensure that collateral can be
pre-pledged collateral in advance. Although not the
expeditiously transferred.
underlying cause of SVB’s and Signature Bank’s failures,
difficulties accessing the DW sparked their failures.
Use by FDIC Bridge Banks
Because they were unprepared, they could not move
In the FDIC’s resolution of the three banks, outstanding
collateral quickly enough. Signature attempted to pledge
DW loans were assumed by bridge banks created by the
ineligible collateral, and SVB struggled to pledge collateral
FDIC, and the SVB and Signature bridge banks received
on the day of its failure. Signature had not tested its DW
new DW loans. The FDIC assumed responsibility for
access in five years and was unfamiliar with basic
repaying the loans and was charged an interest rate one
procedures. In July 2023, the depository regulators issued
percentage point above the discount rate. DW loans to the
updated guidance encouraging—but not requiring—banks
FDIC peaked at $228 billion and were fully repaid (with
to be prepared to use the DW, including by pre-pledging
interest) by November 2023.
collateral, and to periodically test their preparedness. There
was an increase in the number of banks signed up to use the
FDIC use of the DW is not standard and is not explicitly
DW (to 3,900, compared to a total of 4,824) and pledging
contemplated in statute but was approved on the basis that
collateral (to 1,996 pledging $2.6 trillion) in 2023.
bridge banks implicitly meet the criteria of an eligible
institution. It is unclear why the FDIC borrowed from the
Discount Window Modernization
DW instead of the standard practice of using its Deposit
Adding to SVB’s and Signature’s struggles to access the
Insurance Fund and then its line of credit with the Treasury.
DW was the fact that, in the words of Fed Chair Jerome
The FDIC chair testified that the debt limit, which was
Powell, the DW “needs to be brought up technologically
binding at the time, was not the reason. Collateral and FDIC
into the modern age,” which he said is an ongoing project.
guarantees meant that the Fed faced no risk of losses.
According to one study, it “is too cumbersome, is not fully
However, one study estimated that using the DW increased
harmonized across the regional Federal Reserve Banks, and
the FDIC’s resolution costs by $2.5 billion, which was
uses outdated processes and technologies.” The DW did not
borne by banks to the taxpayers’ benefit.
have a web interface until 2024, and that interface still has
limited functionality. The DW also closes at 7 p.m. Eastern
Use of Emergency Authority as an Alternative
time—before SVB, located on the west coast, could secure
During crises, the Fed has created temporary ad hoc
a loan. Critics argue that the speed of deposit runs in the
emergency facilities with fewer limitations under Section
digital age requires a nimbler DW.
13(3) of the Federal Reserve Act. To stabilize the banking
system in early 2023, the Fed created the Bank Term
Interaction with FHLB Advances
Funding Program. By using Section 13(3), the program
One reason that SVB and Signature struggled to borrow
operated with more favorable terms than the DW—longer
from the DW is that they struggled to transfer collateral
maturities, generally lower borrowing rates, and loans
pledged to the Federal Home Loan Banks (FHLBs) to the
based on collateral’s face value instead of market value.
DW. FHLBs are private government-sponsored enterprises
One could view this as an end run around the DW’s
that are a major alternative source of collateralized
statutory limitations. These features reduced the Fed’s
borrowing for banks. According to the FHLBs’ regulator,
profits and increased the risk of taxpayer losses, but
“The reliance of some large, troubled members on the
widespread use was achieved.
[FHLBs], rather than the Federal Reserve, for liquidity
during periods of significant financial stress may be
Role in Liquidity Requirements
inconsistent with the relative responsibilities” of the FHLBs
Large banks are subject to quantitative liquidity
and the Fed. All three banks saw a 37%-50% jump in
requirements, and all banks are supervised for liquidity
FHLB borrowing before their failures, and their peak FHLB
adequacy. These requirements are based on the view that
borrowing exceeded $69 billion combined.
banks should be able to meet their liquidity needs privately.
Therefore, banks do not get credit in the quantitative rules
Unlike the Fed, FHLBs cannot serve as lenders of last
for DW access.
resort, because they cannot provide unlimited liquidity and
could even see their ability to create liquidity contract
The 2023 bank runs call into question the adequacy and
during widespread turmoil. The FHLBs have impeded the
effectiveness of existing liquidity requirements, but
Fed from effectively operating as LOLR in three ways: (1)
requiring banks to hold more liquid assets or stable funding
by exacerbating DW stigma—35% of surveyed banks said
could raise the cost of credit. Some proposals would
they were unlikely to borrow from the DW because of the
incorporate the DW in liquidity requirements by giving
availability of FHLB loans; (2) by potentially allowing
large banks credit toward liquidity requirements for their
banks to become overleveraged—the FHLBs are lending to
DW borrowing capacity, charging banks for mandatory
maximize profits (whereas the Fed has a prudential
credit lines at the DW, or requiring that banks pre-pledge
mandate) and are repaid before the Fed and the Federal
minimum amounts of collateral at the DW (based on
Deposit Insurance Corporation (FDIC) are in the event of a
expected outflows under stress, uninsured deposits and
failure; and (3) by creating barriers to quickly and easily
short-term funding, or all short-term liabilities). Because
transferring collateral to the DW. The FHLBs frequently
DW collateral is subject to a haircut (i.e., banks can borrow
use blanket liens on all assets, and their priority must be
less than the full value of the collateral), these proposals
subrogated before an asset can be pledged at the DW. The
https://crsreports.congress.gov
Federal Reserve’s Discount Window: Policy Issues
could potentially increase the amount of long-term debt and
Marc Labonte, Specialist in Macroeconomic Policy
capital a bank would be required to hold.
IF12655
Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan shared staff to
congressional committees and Members of Congress. It operates solely at the behest of and under the direction of Congress.
Information in a CRS Report should not be relied upon for purposes other than public understanding of information that has
been provided by CRS to Members of Congress in connection with CRS’s institutional role. CRS Reports, as a work of the
United States Government, are not subject to copyright protection in the United States. Any CRS Report may be
reproduced and distributed in its entirety without permission from CRS. However, as a CRS Report may include
copyrighted images or material from a third party, you may need to obtain the permission of the copyright holder if you
wish to copy or otherwise use copyrighted material.
https://crsreports.congress.gov | IF12655 · VERSION 1 · NEW