By Alison Touhey and Joseph Pigg
ABA Viewpoint
Alison Touhey is SVP for bank funding policy at ABA. Joe Pigg is SVP for sustainable finance and mortgage policy at ABA.
The Federal Home Loan Banks and the Federal Reserve’s discount window are two of the most important sources of liquidity for banks. Both are critical to bank funding, although they play different roles. FHLBs are a vital source of day-to-day liquidity funding for many banks and are especially important for community banks. The discount window is meant to address a variety of liquidity needs, although it is primarily considered to be a source of funding in a time of stress.
Recently, the Federal Reserve System has worked to modernize the discount window to ensure its technology meets the contemporary expectations of banks and other users and that its practices are aligned with the variety of liquidity providers. ABA strongly supports these efforts.
However, modernizing the discount window should not create unnecessary and counterproductive competition with or otherwise undermine the FHLBs, which would harm the banking industry. One way to ensure that both the discount window and the FHLBs flourish is to improve the efficiency and ease of the transfer of collateral between the two.
Today, a member bank pledges collateral to the FHLB against collateral for day-to-day funding, based on a legal agreement between it and an individual FHLB. Separately, the same bank enters into an agreement with its regional Federal Reserve Bank to access the discount window. These FHLB and Federal Reserve agreements have many similarities, aimed generally at perfecting interest and mitigating credit risk, but the lending and collateral terms differ across the FHLB and Federal Reserve systems, and often are not standardized even within each system. Moreover, the required data and other information is inconsistent between the FHLBs and discount window, so banks often need to maintain different processes for each. This lack of standardization imposes administrative costs on banks and can delay the speed at which banks are able to access liquidity. ABA strongly supports the current effort to ensure all banks have access to adequate and ready sources of liquidity through the normal course of business as well as during stress events. Establishing consistent agreements among the 12 Federal Reserve Banks and the 11 FHLBs so that collateral can be moved quickly when needed would significantly improve interoperability. Banks need to be able to easily move collateral to the discount window in a crisis and easily and quickly move it back to the FHLBs once the crisis has passed so as not to tie up valuable collateral and deter banks’ ability to lend when credit is most needed.
While the Federal Reserve System has already taken some steps to improve the functionality of the discount window, more work needs to be done to make the process more efficient. Similarly, prudential regulators need to work with the FHLBs’ regulator, the Federal Housing Finance Agency, to ensure that there is a clear understanding of the role that the FHLBs play in meeting both day-to-day funding needs and emergency funding especially since emergency funding needs can arise with lighting speed given modern technology.
ABA’s members have a very strong interest in these issues, and ABA is working to ensure that banks of all sizes have a seat at the table as solutions and tools are developed. ABA has proposed one potential solution: a draft term sheet that will allow for collateral to be transferred easily from FHLB to the discount window and back again. This change would be one of several options for banks, and link with other bank funding sources, and would, together with other necessary changes by the FHLBs and Fed banks, allow banks to seamlessly and quickly move collateral between the discount window and FHLB, receiving funding against that collateral in a fast and efficient manner.
As ABA engages with Fed and FHLB system officials, bankers across the spectrum — from small community banks, mid-size and regional banks all the way up to the G-SIBs — are offering their perspectives on how to strengthen this critical aspect of our financial system. Together, we can build on recent progress to ensure our liquidity provision structure helps financial services providers and their customers thrive.
ABA Viewpoint is the source for analysis, commentary and perspective from the American Bankers Association on the policy issues shaping banking today and into the future. Click here to view all posts in this series.
