Fed’s Barr: Contingency funding planning important to bank resiliency

Federal Reserve supervisors have “stepped up” supervision of interest rate and liquidity risk and will continue to work with banks to ensure balance sheets are “resilient to a variety of conditions,” the Federal Reserve’s Vice Chairman for Supervision Michael Barr told the audience at a conference today in New York City.

Part of that resiliency is due to the importance of contingency funding planning and preparedness, Barr said. “Banks don’t need to sell securities to gain liquidity value from them if they can borrow against them,” he said. “But firms can face challenges in significantly ramping up funding in private markets … particularly if they do not tap those markets regularly.” In July, the Fed and other regulators updated guidance to highlight that banks should maintain a broad array of funding sources, including the Fed lending to banks through the discount window. Liquidity sources not regularly used may not function as expected when most needed, Barr cautioned.

“The discount window is an important tool of both monetary policy and financial stability,” Barr said. It’s important because, with the primary credit rate set at the top of the target range, it supports rate control, he explained, adding that it also provides ready access to liquidity, regardless of market conditions. “The discount window, however, can play these important roles only if eligible institutions are willing and ready to use it. It is important that banks establish borrowing arrangements, pre-pledge collateral and engage in test transactions at regular intervals.”

Barr also addressed the standing repo facility, which was established by the Federal Open Market Committee to help maintain the federal funds rate within the target range if pressures arise in short-term funding markets. It is useful, Barr said, because it gives banks another venue to raise liquidity against Treasury securities and other eligible securities. Barr called an uptick in banks joining the SRF as counterparties “encouraging,” with 10 banks onboarded in the last year, bringing total coverage to about half the assets of the banking system.