By Paritosh Bansal
Feb 27 (Reuters) – Amidst the ebb and flow of financial tides, banks have cautiously ventured into the embrace of the U.S. Federal Reserve’s funding backstop, a lifeline that has lain dormant for more than two years. While this move fortifies their defenses against potential turmoil, the question remains – will they be willing to lean on it in times of crisis?
Resurrecting the Safety Net
Envisioned in July 2021 to shore up money markets following jitters from interest rate spikes, the Standing Repo Facility has garnered tepid response from banks. An aura of reluctance pervaded, fueled by concerns over potential stigma. Borrowing from the Fed during a crisis could cast a shadow on a bank, painting a picture of underlying liquidity woes or other vulnerabilities that may spook investors and regulators. Recent ripples in the market, such as New York Community Bancorp’s trials, serve as vivid reminders of the fragile equilibrium banks must navigate.
Yet, amidst this wariness, signs of change emerge. Market experts and a recent Fed survey offer glimpses of a subtle shift. Banks are tentatively stepping into the fray, a move propelled by regulatory pressures post-March bank runs. The drumbeat of preparedness has grown louder, nudging them towards safeguarding against potential deposit outflows in the ever-shifting sands of the financial landscape.
Rising to the Challenge
As the Fed gears up to siphon off excess cash from the system, concerns loom over impending liquidity droughts. Bill Nelson, chief economist at the Bank Policy Institute, notes a growing tide of bank enlistments in the repo facility. These endeavors signify a burgeoning acceptance of the safety net, once shrouded in hesitation.
Post the March bank tremors, seven U.S. regional banks have taken the plunge. Presently, 26 banks, mainly affiliates of primary dealers, stand as counterparties. Together, they hold sway over a lion’s share of Treasury and agency securities, underlining the pivotal role they play in the financial fabric.
First Citizens Bank, the latest entrant, emphasizes the strategic value, citing the need to expand monetization channels like repo facilities as grounds for their participation.
Anticipating a Shift
The narrative of financial stability hinges upon broadening the pool of banks availing themselves of the repo backstop. A crucial touchstone in tumultuous times, this safety net could spell the difference between survival and demise for banks. Darrell Duffie, a finance professor at Stanford University, likens it to “one more arrow in the quiver”—a shield less tarnished than the discount window, poised to deflect liquidity woes in the storm.
A Fed survey unveiled a mixed landscape, with 21 banks showing interest in joining the chorus of counterparties while 39 remained on the fence. The shifting sands suggest more banks may be on the cusp of joining the fold, heralding a potential surge in enrollments.
Origins of Stability
The genesis of using the repo facility as a financial lifeboat traces back to discussions at the Fed during 2015-16. Nelson, drawing from his central bank stint during that period, narrates the journey towards destigmatizing the discount window. Primarily aimed at mirroring repo markets’ dynamics, the facility bloomed into permanence post the monetary maelstrom of March 2020, catalyzed by the Fed’s bid to mitigate cash shortages.
Though still untouched in crisis waters, a veil of caution shrouds the facility. An industry luminary voiced concerns over potential political backlash for seeking government aid, epitomizing the perpetual dance of perception around tapping into the safety net.
The road ahead remains fraught with uncertainties, but as banks tentatively embrace the Fed repo backstop, the seeds of resilience may sprout into a lush garden of stability, weathering the financial tempests that lie ahead.
(Reporting by Paritosh Bansal; additional reporting by Megan Davies; editing by Anna Driver)
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