As the Bank Term Funding Program (BTFP) nears its conclusion, Wall Street banks are urgently seeking new funding options to sustain liquidity and respond to changing economic conditions.
Wall Street banks are actively exploring new funding options as the Bank Term Funding Program (BTFP), an emergency lending mechanism established in the wake of 2023's regional banking crisis, is nearing its end. The BTFP, which was created to "reinstate confidence" following the collapse of Silicon Valley Bank, will cease to provide loans after the close of business on Monday.
The Federal Reserve faces a significant challenge as it continues to reduce its balance sheet through quantitative tightening, a process that began after years of stimulus during the COVID lockdowns. The expiration of the BTFP raises concerns about whether the U.S. financial system has sufficient tools to maintain necessary cash levels.
Mark Cabana, the head of U.S. rates strategy at Bank of America Corp., commented on the current situation, “Even though funding conditions are stable, banks are still desiring elevated liquidity buffers. BTFP was just one reflection of that.”
The BTFP was introduced in 2023. It allowed banks and credit unions to borrow for up to a year using U.S. Treasuries and agency debt as collateral valued at par. However, the program faced scrutiny when institutions began using it to exploit an arbitrage opportunity, leading the Fed to increase borrowing costs. As of last Wednesday, approximately $164 billion was borrowed through the BTFP, Fed data shows.
With the program's termination, banks must find alternative funding sources or let existing loans mature. This will influence liquidity levels in the financial system and could affect the Fed's balance sheet reduction plans.
Gennadiy Goldberg, head of U.S. interest rate strategy at TD Securities, remarked, “We’re not exactly in scarcity land, but we’re getting closer so it does make sense to slow down.”
The Federal Reserve is concerned that banks choosing not to replace BTFP loans could reduce their reserve balances, which are crucial for weathering financial shocks. Steven Kelly, associate director of research at the Yale Program on Financial Stability, noted that banks' cautiousness in holding higher reserves is partly due to the sense of fragility exposed by last year’s banking issues.
As banks seek other funding sources, two main alternatives have emerged: the Fed’s discount window, which is being rebranded as a routine tool despite its stigma of distress, and loans from Federal Home Loan Banks (FHLB). Fed Chair Jerome Powell and other officials have been pushing for banks to utilize the discount window, and U.S. regulators have considered making it a requirement for banks to tap the facility annually.
Meanwhile, FHLB debt rose by $12 billion in January and February, indicating that demand for short-term loans is robust. Nevertheless, strategies suggest that banks might opt to accumulate cash rather than use the discount window during crises.
The funding markets currently suggest that bank reserves are plentiful, but this topic remains a priority for Fed policymakers, especially as they prepare for the March interest-rate decision.
The Fed's overnight reverse repurchase agreement facility (RRP) is also under scrutiny. If banks embrace alternative funding, it could reduce reliance on the RRP, a key indicator of reserve levels. Dallas Fed President Lorie Logan suggested that as the RRP facility usage declines, the Fed may slow the pace of its balance sheet shrinking, potentially extending the process and mitigating liquidity stress risks.
With the March Fed meeting approaching and the upcoming tax collection deadline, which typically impacts bank reserves, the financial community is closely monitoring the situation. "All eyes are on upcoming tax dates," said Cabana, highlighting the unique challenges faced this year.
In conclusion, Wall Street banks are transitioning toward new funding mechanisms as the BTFP winds down. The decisions made in the coming weeks will have significant implications for liquidity, the Fed's balance sheet policies, and the stability of the U.S. financial system.
