By Michael S. Derby

NEW YORK (Reuters) – Michael Barr, the Federal Reserve’s regulatory chief, stated on Thursday that banks should not worry about the stigma attached to using the U.S. central bank’s discount window liquidity facility and should utilize it when it is financially beneficial for them.

“We view using the discount window as a fully acceptable, normal part of any bank’s funding needs if it makes sense for them to use it from a financial perspective,” Barr, the Fed’s vice chair for supervision, mentioned at a Treasury market conference hosted by the New York Fed.

His remarks, coinciding with the Fed’s plans to propose new bank liquidity rules in the coming months, emphasize that using the discount window should not be interpreted as a sign of liquidity distress. Barr highlighted the central bank’s goal in mitigating the longstanding stigma associated with this essential component of the Fed’s lending toolkit.

Traditionally, the discount window has been recognized as a source of emergency funding for banks facing liquidity challenges. However, banks have often avoided utilizing the discount window, fearing it signals distress, opting instead for it only during periods of extreme stress.

Despite the Fed’s efforts to promote the discount window’s use, these initiatives have struggled to gain momentum. Concerns regarding stigma were so significant during a major stress episode in spring 2023 that the Fed established a separate lending facility to ensure banks had the liquidity they required.

While some Fed officials observed an increase in discount window borrowing during that time as indicative of the facility’s intended function, U.S. central bank research suggests that future ad hoc actions will likely be required due to the enduring stigma surrounding the discount window.

The stress experienced in spring 2023 has prompted the Fed to ensure that banks are well-prepared to utilize the discount window, as many were not adequately ready the previous year. A portion of this effort involves banks pre-pledging collateral for discount-window loans.

Under the forthcoming rules, large banks may be required to maintain a minimum amount of readily available liquidity, including a pool of reserves and pre-positioned collateral at the discount window, based on a percentage of their uninsured deposits, as Barr previously stated.

Additionally, the central bank is contemplating restrictions on large banks’ reliance on “held-to-maturity” assets in liquidity buffers, as liquidating these securities during market turmoil can exacerbate lenders’ stress.

During the Q&A session, Barr indicated that the new regulations would likely be proposed later this year or early next year.

‘READILY AVAILABLE’

Barr highlighted in his prepared remarks that since spring 2023, “over $1 trillion in additional collateral has been pledged to the discount window.”

The Fed’s recent data on discount window readiness revealed a roughly $700 billion increase in pre-pledged collateral from year-end 2022 to year-end 2023.

Moreover, Barr noted that banks have been enrolling in the Fed’s Standing Repo Facility, allowing qualified firms to exchange Treasuries for cash with the Fed. He also recognized a shift enabling banks to use the discount window for assessing their liquidity levels and ability to endure stress periods.

“We see it as acceptable and beneficial for firms to incorporate our facilities to meet liquidity needs in both planning and practice,” Barr asserted.

Barr’s views contrasted with those of Fed Governor Michelle Bowman, who expressed a preference for a more traditional structure. Bowman shared her concerns with the Mid-size Bank Coalition of America Board of Directors Workshop, stating that non-emergency usage and the necessity of collateral posting that could be applied elsewhere might lead to “unintended consequences.”