By Dan Brown and Aakash Gupta
ABA DataBank
ABA recently surveyed members on this subject. The survey indicates that convenience is a key driver of the decision to use a particular liquidity source, across all environments and that the FHLB system is a primary source of liquidity for many banks in almost all market conditions. Meanwhile, the discount window remains an important source of contingent liquidity — which leads to several opportunities for the Fed to improve the functioning of the window. This analysis includes some recommendations.
Overview of collateralized borrowing
Collateralized borrowing, where banks pledge assets to secure funding, is deeply embedded in banks’ liquidity practices. Almost 70 percent of institutions report the use of collateralized borrowing routinely. Banks typically keep a buffer of liquid assets to sell or use as collateral for borrowings in times of stress, for large banks the size of the buffer is determined by the liquidity coverage ratio. While there are several sources of collateralized borrowing, ABA’s survey focused on the FHLB System and the discount window.
A diverse array of ABA member banks responded to the survey. The majority of respondents are community banks with less than $10 billion in assets, which largely tracks industry composition, where 96 percent of the 4,300 banks are community banks, 3 percent are midsize and 0.7 percent are regional and global systemically important banks. These findings come as the Federal Reserve is considering operational and policy changes intended to improve the effectiveness of the discount window.
FHLB advances serve as the first stop for many banks seeking secured borrowings for day-to-day liquidity, while survey respondents mainly reserve the discount window for severe stress.
- Roughly 90 percent of respondents identified FHLB advances as the most frequently used collateralized borrowing source for daily liquidity.
- The discount window was used less often for routine funding, with the discount window ranked first by only about 12.5 percent of respondents.
- With respect to contingent funding, 97.2 percent of institutions reported including collateralized borrowing in their contingency funding plans, or CFPs.
- Among those using collateralized borrowing in their CFPs, 100 percent expect to use FHLB advances.
Across all stages of the business cycle, cost and convenience are the dominant decision drivers. Within the context of bank contingency planning, available collateral and relationship with provider move up in relative importance.
FHLB use
Approximately 98 percent of institutions reported using FHLB membership for liquidity purposes within the past 12 months. Survey respondents indicated a preference for FHLB advances over other sources of liquidity because they offer:
- Flexible terms across a broad maturity spectrum, although respondents indicated a preference for short-dated advances, with survey respondents choosing overnight as their most popular borrowing length. (See a related ABA DataBank post.)
- Blanket lien collateral arrangements that reduce transaction level burden and leverage existing loan reporting and examination processes
- Fast, predictable post trade funding and operational simplicity in both setup and ongoing administration
FHLB advances are used for both day-to-day liquidity and contingent liquidity, supporting a variety of risk management and lending activities (especially lending supporting housing initiatives) with cash and asset-liability management activities. On the lending side, FHLB borrowing supports single-family residential lending, small business lending, asset-liability management, and general cashflow and liquidity management.
While virtually all banks use FHLBs for routine liquidity needs, nearly 40 percent of respondents also reported using FHLBs as a source of emergency liquidity.
Making the window usable for banks of all sizes
Almost all, or 88 percent, of survey respondents describe themselves as operationally ready to use the discount window, meaning they have completed all the legal documentation and pledged collateral. Among those not ready, the main barrier includes burdens associated with pledging collateral.
Three out of five respondents said “legal documents being too complex” was their number one reason for not being discount window-ready. Lack of an easy, online interface was ranked among the top three barriers for two-thirds of respondents.
About a third of the banks that say they are not currently discount window-ready plan to become discount window-ready within the next year.
Banks regularly test their lines at the discount window, with over 80 percent of respondents reporting they have used the discount window within the past year. Over 70 percent indicated that their last draw at the window was for testing purposes, with far fewer citing defensive liquidity or overdraft avoidance.
These patterns are consistent with previous ABA research, which found banks primarily use the discount window as an emergency or backup facility rather than a day-to-day liquidity tool.
The survey elicited detailed feedback on potential technical fixes and priority areas for discount window modernization. Overall, survey respondents viewed the discount window’s processes and procedures as too cumbersome.
Survey respondents identified several priority areas for future discount window reform:
- Simplifying initial access setup and legal documentation
- Reducing stigma associated with discount window use
- Simplifying pledging securities/loan collateral (especially borrower-in-custody, or BIC)
- Increasing efficient movement of collateral across liquidity providers
- Providing clear online guidance
The survey included an open-ended question about how the discount window should be improved. Respondents suggested that an expansion of the discount window’s suite of funding products — especially longer-term options — and a simplification of the pledging process (particularly BIC arrangements) would be helpful. Further suggestions included: digitizing and consolidating discount window processes into a “one-stop shop” dashboard; standardizing collateral eligibility and reporting with FHLBs and other liquidity providers; and increasing automation.
Together, these findings underscore the critical role that both the FHLB system and the discount window play in banks’ liquidity planning and highlight opportunities to modernize the discount window to better support institutions across all market conditions.
Dan Brown is a senior director and economist, and Aakash Gupta is an economic research associate in ABA’s Office of the Chief Economist. ABA policy contacts on this issue are Alison Touhey and Joe Pigg.
