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Discussion of “Evaluating Monetary Policy Operational Frameworks” by Ulrich Bindseil: remarks at the 2016 Economic Policy Symposium at Jackson Hole, Wyoming
Remarks at the 2016 Economic Policy Symposium at Jackson Hole, Wyoming.
Why Do Central Banks Have Discount Windows?
Though not literally a window any longer, the “discount window” refers to the facilities that central banks, acting as lender of last resort, use to provide liquidity to commercial banks. While the need for a discount window and lender of last resort has been debated, the basic rationale for their existence is that circumstances can arise, such as bank runs and panics, when even fundamentally sound banks cannot raise liquidity on short notice. Massive discount window borrowing in the immediate aftermath of the September 11 terrorist attack on the United States clearly illustrates the ...
Discount window stigma during the 2007-2008 financial crisis
We provide empirical evidence for the existence, magnitude, and economic cost of stigma associated with banks borrowing from the Federal Reserve?s Discount Window (DW) during the 2007-08 financial crisis. We find that banks were willing to pay a premium of around 44 basis points across funding sources (126 basis points after the bankruptcy of Lehman Brothers) to avoid borrowing from the DW. DW stigma is economically relevant as it increased some banks? borrowing cost by 32 basis points of their pre-tax return on assets (ROA) during the crisis. The implications of our results for the provision ...
Is There Stigma to Discount Window Borrowing?
The Federal Reserve employs the discount window (DW) to provide funding to fundamentally solvent but illiquid banks (see the March 30 post “Why Do Central Banks Have Discount Windows?”). Historically, however, there has been a low level of DW use by banks, even when they are faced with severe liquidity shortages, raising the possibility of a stigma attached to DW borrowing. If DW stigma exists, it is likely to inhibit the Fed’s ability to act as lender of last resort and prod banks to turn to more expensive sources of financing when they can least afford it. In this post, we provide ...
Dealer financial conditions and lender-of-last resort facilities
We examine the financial conditions of dealers that participated in two of the Federal Reserve?s lender-of-last-resort (LOLR) facilities--the Term Securities Lending Facility (TSLF) and the Primary Dealer Credit Facility (PDCF)--that provided liquidity against a range of assets during 2008-09. Dealers with lower equity returns and greater leverage prior to borrowing from the facilities were more likely to participate in the programs, borrow more, and--in the case of the TSLF--at higher bidding rates. Dealers with less liquid collateral on their balance sheets before the facilities were ...
Which Dealers Borrowed from the Fed’s Lender-of-Last-Resort Facilities?
During the 2007-08 financial crisis, the Fed established lending facilities designed to improve market functioning by providing liquidity to nondepository financial institutions—the first lending targeted to this group since the 1930s. What was the financial condition of the dealers that borrowed from these facilities? Were they healthy institutions behaving opportunistically or were they genuinely distressed? In published research, we find that dealers in a weaker financial condition were more likely to participate than healthier ones and tended to borrow more. Our findings reinforce the ...
Why Do Banks Feel Discount Window Stigma?
Even when banks face acute liquidity shortages, they often appear reluctant to borrow at the New York Fed’s discount window (DW) out of concern that such borrowing may be interpreted as a sign of financial weakness. This phenomenon is often called “DW stigma.” In this post, we explore possible reasons why banks may feel such stigma.