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Part of the job of the Federal Reserve (also known as the Fed) is to ensure stability throughout the economy so that its monetary policies can be effectively implemented. And sometimes, that means bailing out banks when they make bad investments.
The Fed is often called the “lender of the last resort” because it provides liquidity to banks that have run out of borrowing options and find themselves on the brink of collapse. The Fed’s discount window, for example, is a “no questions asked” source of funding that eligible banks can tap into on an overnight basis. But sometimes, even that is not enough.
What Is the Bank Term Funding Program (BTFP)?
In the aftermath of the collapse of Silicon Valley Bank and Signature Bank in March, 2023, the Federal Reserve created a new program to help troubled regional banks with the hopes of averting bank runs and more widespread financial contagion.
The Bank Term Funding Program, or BTFP, is a new form of one-year emergency funding available to eligible financial institutions. These institutions must pledge collateral that the Fed can purchase through its open market operations, such as Treasury securities and other debt obligations.
The unique aspect of this new program is how generous its terms are—according to Fed Chairman Jerome Powell, the securities offered up as collateral are priced at par value, which is their original value and not their market value.
“This program, along with our long-standing discount window, is effectively meeting the unusual funding needs that some banks have faced and makes clear that ample liquidity in the system is available,” he said at the Federal Open Market Committee press conference on March 22, 2023.
“Our banking system is sound and resilient, with strong capital and liquidity. We will continue to closely monitor conditions in the banking system and are prepared to use all of our tools as needed to keep it safe and sound. In addition, we are committed to learning the lessons from this episode and to work to prevent episodes/events like this from happening again.” —Fed Chair Jerome Powell, March 22, 2023
Why Was the Bank Term Funding Program Created?
The 2023 collapse of Silicon Valley Bank, quickly followed by the collapse of Signature Bank, spooked the markets. Investors sold bank stocks and flocked to safer investments like bonds. But perhaps the greatest threat was to the regional banking system as a whole, because if depositors had begun withdrawing their funds from banks in unison, they could have triggered bank runs. This would be felt through the economy like a set of falling dominoes, effectively crippling entire parts of the country since rural counties rely on a small number of financial institutions for their deposits and credit.
The Bank Term Funding Program is one way the Fed attempted to inject confidence into the banking system and assure depositors that their money is safe. On its website, the Fed confirmed that the Bank Term Funding Program was designed “to help American businesses and households to make sure banks have the ability to meet the needs of their depositors.”
What Is the Bank Term Funding Rate? How Long Is It Available?
The interest rate for Bank Term Funding loans is published daily on the Fed’s discount window website.It is a fixed rate consisting of the one-year overnight index swap rate (OIS) plus 10 basis points. As of April 21, 2023, that rate was 4.95%.
According to the Fed, this special interest rate began on March 12, 2023, and is set to continue “at least” through March 11, 2024.
How Have Interest Rates Influenced the Bank Term Funding Program?
Bond prices have an inverse relationship to interest rates: When interest rates rise, the value of bonds decreases, and vice versa.
After witnessing a historic acceleration of inflationary pressures following the COVID-19 pandemic, the Fed implemented a series of steep rate hikes in 2022, increasing the Fed funds rate from near zero in the first quarter of 2022 to a range between 4.75% and 5.00% in March 2023. This undercut a lot of the reserves held in banks, which often hold Treasury bonds and other U.S.-backed debt. Silicon Valley Bank and Signature Bank both held large unrealized losses on their holdings of government bonds, making them especially vulnerable in times of stress.
According to the Fed, the Bank Term Funding Program provides a backstop, or an additional source of liquidity against these securities, thus preventing a financial institution from having to sell these securities in times of distress and ultimately avoiding default.
Who Is Eligible for Bank Term Funding? How Do Eligible Financial Institutions Apply?
Any federally insured U.S. depository institution, such as a bank, credit union, or savings association) that is eligible for primary credit under the Fed’s discount window can apply for the Bank Term Funding Program. Non-depository institutions and institutions eligible for secondary credit are not eligible for this program.
In order to enroll in the Bank Term Funding Program, eligible institutions should submit an email request to their Federal Reserve Bank. Templates can be found on the Bank Term Funding Program’s webpage.
The Bank Term Funding Program vs. the Discount Window
The Fed’s discount window is its main “safety valve” for emergency funding, but the primary credit rate of interest, set at 100 basis points higher than the Fed funds rate, is actually more expensive than the interest offered through the Bank Term Funding Program.
In addition, the Bank Term Funding program values collateral differently than the discount window. Collateral pledged through the Bank Term Funding program is not totally secured, which means the Fed is exposed if the bank defaults and cannot repay its obligations.
However, since federally guaranteed debt securities are backed by the “full faith and credit” of the U.S. government, and thus virtually assured to never default, the Fed is effectively leaning on its own stellar reputation by offering banks such an attractive deal. And with $150.8 billion already pledged through the program as of April 21, 2023, banks seem eager to take up their offer.
