Discount Window Stigma Plagues Banks
NEW YORK ( MainStreet) Six years after the 2008 financial crash, the Federal Reserve, the U.S. central bank, has left unanswered questions about how it managed the crisis and its lingering aftermath. In an April 23 speech to the Economic Club of Canada, out-going Fed chair Ben Bernanke threw a bone to those still scratching their heads.
"I still think there are a lot of people out there who really don't understand why we did what we did," he told his Toronto audience, despite nearly 300 speeches and numerous Congressional appearances. He added, "They think somehow or another we favored Wall Street over Main Street ."
Among the Fed's concerns in 2008 were banks that were afraid to lend money to each other. A place where the Fed dispenses cash to liquidity-starved banks that can't borrow from their peers is the Fed discount window, or the Fed DW, a critical Federal Reserve lending facility. A January 15 post on the Fed's Liberty Street blog "Why Do Banks Feel Discount Window Stigma?" including a 71-page staff report examines the DW's performance during the financial crisis, but raises many questions, including ones that go beyond the discount window.
The Federal Reserve's 100-year-old DW makes secured, short-term loans when other sources of liquidity dry up, particularly in the Fed funds market, where loans are typically made overnight by banks with excess cash to banks with a temporary shortfall. In the early days, a bank would send an employee with a money bag to a Fed teller window, although physical Fed teller windows continued to operate into the 1960s. Assisting banks with cash flow is a key role at a central bank, when it acts as the lender of last resort.
The Fed calls these loans "advances," charging about 1% above the Fed funds rate in recent years. Commercial banks, thrifts and U.S. branches of foreign banks are eligible. Banks with liquidity problems can get money; those that are insolvent are supposedly shut out.
But banks face "discount window stigma," which assumes that if you're borrowing at the DW, you're in dodgy shape and could be a risk to counterparties. The loans are supposed to be anonymous, but word can end up on the street.
Borrowers in the 11 Fed districts outside New York could be exposed, the blog noted, through a weekly Fed report "in which DW borrowings are aggregated by Federal Reserve District" and published every week in the Fed's H.4.1 release. Banks may speculate that a peer that suddenly disappears from the Fed funds market probably went to the discount window.