Fed’s Discount Window Can Serve as a Standard Funding Source for Banks, Says Barr

By Michael S. Derby

Michael Barr, the Federal Reserve’s regulatory chief, stated on Thursday that banks should not be concerned about the stigma associated with utilizing the U.S. central bank’s discount window liquidity facility, encouraging them to take advantage of it when appropriate.

"We consider the use of the discount window to be a fully acceptable and normal aspect of any bank’s funding strategy if it aligns with their financial needs," Barr, the Fed’s vice chair for supervision, remarked at a Treasury market conference hosted by the New York Fed.

His comments, made as the Fed prepares to introduce new bank liquidity regulations soon, suggested that tapping the discount window should not be interpreted as a sign that a bank is facing liquidity issues. Barr emphasized the central bank’s efforts to eliminate the long-standing stigma linked to this vital component of its lending toolkit.

Historically, the discount window has been seen as a resource for emergency funding for banks encountering liquidity challenges. Many banks have avoided using it, fearing that doing so would signal financial distress, opting instead for its use only during severe market stress.

Despite the Fed’s attempts to promote the use of the discount window, these initiatives have not yet gained significant momentum. Concerns over the associated stigma were so pronounced that during a major wave of stress in the spring of 2023, the Fed established a separate lending facility to ensure that banks had sufficient liquidity.

While some Fed officials interpreted the increase in discount window borrowing during that period as evidence that the facility is functioning correctly, research from the U.S. central bank has indicated that ongoing ad hoc measures will likely be needed due to the persistent stigma.

The challenges faced during the spring of 2023 have prompted the Fed to ensure that banks are adequately prepared to utilize the discount window, as many were not equipped to do so the previous year. This preparation includes requiring banks to pre-pledge collateral for discount window loans.

Under the new regulations being considered, large banks may be obligated to maintain a minimum amount of readily available liquidity through a combination of reserves and pre-positioned collateral at the discount window, reflecting a fraction of their uninsured deposits, Barr has noted. The central bank is also evaluating potential limitations on large banks’ reliance on held-to-maturity assets in their liquidity buffers, as liquidating these securities in turbulent market conditions can exacerbate stress on lenders.

During a Q&A session, Barr indicated that these new rules are likely to be proposed later this year or early next year.

Barr highlighted that since the spring of 2023, "over $1 trillion in additional collateral has been pledged to the discount window." Data from the Fed revealed an increase of approximately $700 billion in pre-pledged collateral from the end of 2022 to the end of 2023.

He also noted that banks have been enrolling to use the Fed’s Standing Repo Facility, which allows eligible firms to exchange Treasuries for cash with the Fed. Barr mentioned a recent shift allowing banks to incorporate the discount window into their liquidity assessments and stress resilience strategies.

"We view it as both acceptable and beneficial for firms to integrate our facilities as a means to address liquidity needs in their planning and execution," Barr stated.

Barr’s remarks contrasted with those of Fed Governor Michelle Bowman, who expressed support for a more traditional approach. Bowman conveyed her concerns at a workshop for the Mid-size Bank Coalition of America, arguing that non-emergency usage and mandatory collateral posting could lead to "unintended consequences."