The Federal Reserve’s New Bank Term Funding Program

On Sunday, March 12, in an effort to demonstrate support for the banking system, the Federal Reserve Board created the Bank Term Funding Program (BTFP) to make available additional funding to eligible depository institutions. This new program will provide an additional source of liquidity for financial institutions with an asset-liability duration mismatch relating to high-quality collateral, with the goal of providing banks an alternative to quickly selling off high-quality collateral at current discounted market values to fund liquidity needs.

In its announcement, the Federal Reserve Board stated the BTFP will “bolster the capacity of the banking system to safeguard deposits and ensure the ongoing provision of money and credit to the economy.” The program first became available on March 13, and financial institutions borrowed over $11.9 billion allocated from the BTFP during its first week. During the same week, borrowing at the Federal Reserve discount window increased by over 3,000% to $152.85 billion.

Eligibility for BTFP: Who can borrow?

Any U.S. federally insured depository institution (including banks, savings associations, and credit unions), as well as any U.S. branch or agency of a foreign bank that is eligible for primary credit (see 12 C.F.R. § 201.4(a)), is eligible to borrow under the BTFP.

Financial institutions that already have discount window borrowing documentation under the Federal Reserve Banks’ (FRB) Operating Circular No. 10 (Lending) are able to borrow from the BTFP immediately. Other financial institutions can contact their district FRB to determine the documentation needed to participate in the BTFP.

BTFP Terms: How does it work?

There is no restriction on the number of times an eligible financial institution can access the BTFP. The funds will be available for a term of up to one year, and borrowers may pledge U.S. Treasuries, agency debt, mortgage-backed securities, and certain other high-quality assets as collateral (see Exhibit A for a detailed list of current eligible collateral and 12 C.F.R. § 201.108(b)). The collateral valuation will be 100% of par value regardless of the current market value of the collateral. The loans are made with full recourse to the eligible borrowers beyond the pledged collateral. Borrowers may prepay advances at any time without penalty, and the BTFP is currently scheduled to end on March 11, 2024. The Department of the Treasury has allocated up to $25 billion from the Exchange Stabilization Fund as a backstop for the BTFP in the event of any borrower default, but the Federal Reserve Board stated that it does not anticipate having to make any draws from the backstop funds.

Financing: How much does it cost?

The fixed interest rate for term advances under the BTFP will be the one-year overnight index swap rate plus 10 basis points, as of the date the advance is made. There are no fees for a borrower to participate in the BTFP.

Balance Sheet Implications

A large tenet of the BTFP is swapping bank-owned quality assets for the cash that financial institutions need to support liquidity to protect themselves from becoming victim to a potential run on deposits, which could otherwise force the sale of assets and crystalize current mark-to-market losses on the quality collateral. These assets will become a part of the Federal Reserve’s balance sheet, and depending on the BTFP’s utilization rate, the balance sheet could see significant growth. As of March 15, 2023, the Federal Reserve’s balance sheet expanded by $297 billion to $8.63 trillion, reaching the highest amount since November 2022. As a result, the Federal Reserve’s stated intention to reduce its balance sheet likely will be put on hold.

The financial institutions participating in the BTFP have the potential to change their balance sheets: a bank looking to protect decreasing deposits could effectively be shielded from realizing the mark-to-market losses on its high-quality assets. Additionally, this could act as a price support for those assets. For example, billions of dollars in assets may fail to reach the current market, and in a future market, could potentially result in even larger mark-to-market losses. Also of concern is the fact that the financing costs of the BTFP will be greater than the income from the pledged assets, generating additional current income losses for the participating financial institutions. While it is too early to predict the true impact the BTFP will have on the current liquidity issues facing the banking system, the Federal Reserve, and the BTFP participants, it is clear that the BTFP could transform the balance sheets of all.

Why still utilize the discount window?

The BTFP, with its new offerings and favorable terms, is not replacing the discount window. Financial institutions are still drawing from the discount window, and in record-breaking amounts. Federal Reserve data showed a total of $152.85 billion borrowed from the discount window as of March 15, which is $41 billion higher than the previous record of $111 billion set in 2008. Whether to borrow from the BTFP or the discount window depends on the needs of each respective financial institution. However, one of the largest deterrents of the BTFP is its more stringent collateral requirements.

Discount Window vs. BTFP and Important Changes

Perhaps the largest difference between the BTFP and the discount window are the collateral requirements, with fewer types of collateral qualifying for the new program. These stricter collateral requirements make the BTFP less helpful to financial institutions without a large percentage of assets in securities because such banks generally do not have enough high-quality assets on their balance sheet for the BTFP to give them the same benefits.

Collateral under BTFP is valued at par. The discount window previously valued collateral at fair market value, but as of March 12, 2023, certain other collateral that is eligible for the BTFP is also valued at par at the discount window. Specifically, the discount window is currently lending at par for Treasuries, agency debt, and agency mortgage-backed securities. The Federal Reserve Board announced this change to help protect borrowers from the recent and future interest rate hikes and increase the lendable value of the high-quality collateral at the discount window.

As for the requirement for a borrower under the BTFP to have owned collateral as of March 12, 2023, for it to be eligible, the Federal Reserve Board provided guidance on March 16th for merged entities. If two federally insured depository institutions merge and the surviving institution of the two is an eligible borrower, the assets of the surviving institution would be eligible collateral if the assets (i) are eligible for purchase by the FRBs in open market operations and (ii) were owned by either merger party as of March 12. Similarly, if a federally insured depository institution or U.S. branch or agency that is an eligible borrower (the purchaser) acquires all or substantially all of the assets of a federally insured depository institution or a U.S. branch or agency of a foreign bank, the assets of the purchaser would be eligible collateral if they (i) are eligible for purchase by the FRBs in open market operations and (ii) were owned by either the purchaser or a federally insured depository institution as of March 12. Finally, if an eligible borrower purchases particular assets, or a portfolio of assets, from another institution after March 12, those assets are not eligible collateral for purposes of the BTFP.

The fixed interest rate of the advances under the BTFP versus the floating interest rate available from the discount window is another notable difference. In addition, the BTFP allows financial institutions to lock in the fixed interest rate on the advance for the term of the advance to avoid any interim increases in interest rates as happened on March 22, 2023. Further, the BTFP could allow financial institutions to take advantage of lower future market interest rates by prepaying the facility and drawing down at the lower rate as the advances are pre-payable.

Finally, advances for BTFP can be made for a term of up to one year, as opposed to up to 90 days for the discount window. Operating Circular No. 10 (OC 10) governs advances from the BTFP and the discount window because OC 10 contains the terms under which an entity may obtain advances from, incur obligations to, or pledge collateral to a FRB.

The greatest lingering question with the BTFP is what will happen when the BTFP ends in one year, on March 11, 2024.

For your reference, please see (i) the term sheet released by the Federal Reserve, (ii) the FAQs document released by the Federal Reserve, and (iii) attached as Exhibit A, a copy of the collateral chart published by the Federal Reserve to determine what type of collateral is currently eligible for purchase at the discount window.

Exhibit A

© Arnold & Porter Kaye Scholer LLP 2023 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.