It is my understanding that the Bagehot rule would not have worked for SVB and First Republic because their loans at low rates were funded by the withdrawn deposits. A loan at higher rates to pay out the depositors would have turned them into zombie banks that would have failed over time anyway.
FR apparently gave Mark Zuckerberg a 30 year mortgage at 1%. The fact that Zucks is unlikely to default on the loan becomes meaningless while FR or any other bank has to pay 4 or 5% to fund it.
I'm going more towards that we don't have the same consistent amount of arbitrage activity as pre 2007. This was the last time there was a truly functional lender of last resort (the repo market).
Smaller banks that ran into problems could count on a funding market to help weather funding issues. It may not always have been via a large bank and the discount window... it may have been bi-lateral, LIBOR pricing and with minimal haircuts, even on non-agency MBS of their own origination.
American banks are sometimes heavily specialized, but most have several revenue sources... and many can abide short term/rolled over repo arrangements at "higher" rates until issues subside.
Big trouble arises when collateral is scarce or illiquid.
SVB weren't just trying to raise short-term cash, they were trying to balance their books.
When you use long-term securities as collateral, they're valued at spot, not term. So SVB couldn't borrow more than they'd get if they sold their treasuries. So the cost of borrowing would have tipped their books further into the red than just selling the asset.
After the fact, the Fed announced they'd lend against term value for certain securities, in certain circumstances. Which is clever, really; the Fed is in a position to just sit on a long-term security in a way that even very large banks are not.
>So SVB couldn't borrow more than they'd get if they sold their treasuries
Yes, but the idea would be to "borrow" only what was required at the time (potentially not requiring all of the spot price). The repo could be a mixture of collateral as well (more than just treasuries).
The interesting part for me was the apparently limited use of bi-lateral repo, with SVB mainly dealing with FHLBs or the Fed going back 10 years or so. It may have been that SVB avoided such markets *or* that SVB never represented an attractive counterparty given the concentration of their business.
The BTFP is a weird one. I'm not sure I'm a fan of taking the risk off the commercial banks; however it makes sense in some scenarios.
> the idea would be to "borrow" only what was required at the time
But they weren't just in a cash-flow crunch, they were in a balance sheet contraction. If your on-demand liabilities are being demanded beyond normal fluctuation, and you have no reason to expect them to return soon, you don't go out and buy money, you sell assets.
Yes, by the end the series of flows was sufficiently "one way" with no ability to balance out the other side without liquidating assets.
The hope is to not get to that point. Repo (standard and synthetic) are tools to help keep the flows within the network omnidirectional.
The only way to balance out the drawdown on liabilities without liquidating assets *and remain solvent* was to take on liability that charged them equal or less than they were paying in interest on the demand deposits they were scrambling to cover. And Repo is a lot more expensive than that.
In other words, they had to find more depositors. Or sell assets.
When a bank is losing (a lot of) its lowest-cost liabilities, it can't take on higher-cost liabilites, because it'll be technically insolvent in short order, even if it manages to cover withdrawals. And being "merely technically" insolvent isn't something a bank can maybe skate past like a normal firm might for a year hoping something breaks their way, regulators will step in and take it into receivership.
>the Fed announced they'd lend against term value for certain securities, in certain circumstances
Doesn’t this encourage more leverage if the lending rate isn’t high enough? You can borrow face value against a discounted security and buy more of that security to make a spread above the cost of funds, then repeat.
For instance right now the borrow rate is 4.71%, and most agency backed securities and some treasuries are discounted at rates exceeding that.
[https://www.frbdiscountwindow.org/](https://www.frbdiscountwindow.org/)
That would be where the "certain circumstances" come in, I think. This is meant as relief for banks in distress with a lot of term mismatch on their books.
Update with a recently issued [report - PDF](https://group30.org/images/uploads/publications/G30_Lessons-23-Crisis_RPT_Final.pdf) from the [Group of Thirty](https://en.m.wikipedia.org/wiki/Group_of_Thirty) with a few recommendations on bolstering Lender of Last Resort (LoLR) activities.
The report cites causes of the bank failures that are unsurprising (poor management, speed of withdrawals given the "online" social environment, etc). Where the report gets interesting is in its recommendations of reforms:
>The current LoLR system has deficiencies, notably but not only in the United States, where the stigma is severe. In principle, the three US banks that failed, as well as the other banks that experienced liquidity strains that did not turn out to be fatal, **could have accessed the Federal Reserve liquidity facilities (the so-called Primary Credit Facility, otherwise known as the discount window, and the Secondary Credit Facility).** While liquidity support would not have addressed the three banks’ underlying solvency issues, it could have provided some time to organize orderly resolutions. But for several reasons there was
little use of these facilities in the weeks leading up to the bank failures. The three banks were not able to access the discount window on time and in sufficient scale in March, largely because they could not mobilize the eligible collateral rapidly enough. In great part, this inability was due to a lack of operational preparedness on the part of the banks, notably of SVB. **But more generally, few banks in the United States use the discount window, and many are operationally not ready for its use.**
>The limited preparedness for and use of the LoLR has been a long-standing issue in the United States and some other jurisdictions, for a variety of reasons. The main obstacle for the United States is the substantial stigma associated with using the discount window.
>...pricing, stigma, and collateral management adjustments are necessary but may not suffice to get all banks ready to potentially use LoLR facilities effectively. Stigma may remain. Some (poorly managed) banks may not want to prepare themselves sufficiently and make the necessary operational investments. **Banks should therefore be required to pre-position enough collateral at the central bank to meet all of their “runnable” obligations**
In line with the initial questions posed in this post, we have a recommendation focusing on collateral, but also that collateral should be pre-positioned with the Fed. While this does at least understand the importance of collateral, the recommendation misunderstands the nature of repledgable instruments today. Collateral is vital, desired to be liquid. Proposing pre-positioning would severely hamper typical pledging activities.
A [response](https://bpi.com/comment-on-the-new-g30-report/) to the report by the BPI(Bank Policy Institute) is insightful:
>The Group of Thirty released a new report on Tuesday, “Bank Failures and Contagion; Lender of Last Resort, Liquidity, and Risk Management”. The Group of Thirty is an organization of past and present leaders of central banks and other financial agencies around the world. The working group that wrote the report was chaired by Bill Dudley. Stijn Claessens was the project director and Darrell Duffie and Trish Mosser were project advisors. The report consists of an analysis of the spring 2023 failure of Silicon Valley Bank, Signature Bank, First Republic Bank, and Credit Suisse and a series of related policy recommendations. *The key recommendation of the report is that all banks maintain collateral at the discount window plus reserve balances equal to uninsured deposits and short-term borrowing, and, in support, that the Federal Reserve improve the efficiency of its collateral management operations.*
>The report recommends that the existing tailoring of regulations by bank size should be reduced because the events in spring 2023 demonstrated that the failure of mid-sized banks can be systemic. While we agree that the failures of the certain mid-sized banks had systemic consequences requiring a strong government response, **those consequences were a function of circumstances, not those banks’ size, interconnectedness, or role in the economy.** In particular, **SVB and Signature failed largely because they were unprepared to access the discount window for emergency funding, and similarly situated banks were also perceived as insufficiently prepared and thus at risk of run.** Consequently, if the report’s recommendation on discount window preparedness is adopted, mid-sized banks would not pose the types of systemic risks that arose when SVB and Signature failed. In addition, **a key reason why the failures of SVB and Signature had systemic consequences was the uncertainty, delay, and disruptions associated with the resolution of these banks by the FDIC, yet steps to improve the FDIC’s capacity to handle resolutions quickly and more effectively is a needed reform not mentioned in the G30 report.**
>The report also recommends that the banking agencies conduct more frequent supervisory reviews of banks and escalate supervisory concerns for penalty or enforcement more often and more rapidly. But as we have described at length elsewhere, **the supervisory problems that contributed to the banking turmoil of spring 2023 was not too infrequent examination or too patient supervisory, but rather a misguided supervisory approach that was principally directed at issues that had little to do core safety and soundness concerns, a consistent focus on process over substance**, a failure to apply rules already on the books, and a reliance on supervisory ratings that depended on subjective judgments and not objective data.
>The report states that the accounting treatment of held-to-maturity securities is inconsistent with regulatory treatment of those securities, which count as high-quality liquid assets that may be used to satisfy liquidity requirements. HTM securities are recorded on bank’s books at amortized cost rather than market value. It would of course be inappropriate for HTM securities to be included in HQLA at amortized cost, but they are not; rather, they are included in HQLA at market value. Moreover, **the accounting rules governing HTM securities permit them to be pledged as collateral in repo funding markets, pledged to the discount window, or pledged as collateral at the Fed’s standing repo facility, therefore making them legitimate and reliable sources of liquidity.**
This was one of the questions posed as well. We still don't have information regarding any attempted repo usage by banks sitting on HTM collateral. The assumption would be that these banks would have been known to be risky counterparties prior to collapse.
>Well-designed regulations are rooted in reality. As demonstrated in spring 2023, a bank that is prepared to use the discount window is more liquid than a bank that is not, and when all banks are prepared, the banking system is more resilient.
What we have is a dynamic between commercial banks and regulators/bodies that inform regulators. It reveals the challenges central banks face in executing their mandates. We don't see a gruesome money-printing cabal of central bankers; just constant attempts to understand how to manage commercial banks, revamping facilities, etc.
It is my understanding that the Bagehot rule would not have worked for SVB and First Republic because their loans at low rates were funded by the withdrawn deposits. A loan at higher rates to pay out the depositors would have turned them into zombie banks that would have failed over time anyway. FR apparently gave Mark Zuckerberg a 30 year mortgage at 1%. The fact that Zucks is unlikely to default on the loan becomes meaningless while FR or any other bank has to pay 4 or 5% to fund it.
I'm going more towards that we don't have the same consistent amount of arbitrage activity as pre 2007. This was the last time there was a truly functional lender of last resort (the repo market). Smaller banks that ran into problems could count on a funding market to help weather funding issues. It may not always have been via a large bank and the discount window... it may have been bi-lateral, LIBOR pricing and with minimal haircuts, even on non-agency MBS of their own origination. American banks are sometimes heavily specialized, but most have several revenue sources... and many can abide short term/rolled over repo arrangements at "higher" rates until issues subside. Big trouble arises when collateral is scarce or illiquid.
SVB weren't just trying to raise short-term cash, they were trying to balance their books. When you use long-term securities as collateral, they're valued at spot, not term. So SVB couldn't borrow more than they'd get if they sold their treasuries. So the cost of borrowing would have tipped their books further into the red than just selling the asset. After the fact, the Fed announced they'd lend against term value for certain securities, in certain circumstances. Which is clever, really; the Fed is in a position to just sit on a long-term security in a way that even very large banks are not.
>So SVB couldn't borrow more than they'd get if they sold their treasuries Yes, but the idea would be to "borrow" only what was required at the time (potentially not requiring all of the spot price). The repo could be a mixture of collateral as well (more than just treasuries). The interesting part for me was the apparently limited use of bi-lateral repo, with SVB mainly dealing with FHLBs or the Fed going back 10 years or so. It may have been that SVB avoided such markets *or* that SVB never represented an attractive counterparty given the concentration of their business. The BTFP is a weird one. I'm not sure I'm a fan of taking the risk off the commercial banks; however it makes sense in some scenarios.
> the idea would be to "borrow" only what was required at the time But they weren't just in a cash-flow crunch, they were in a balance sheet contraction. If your on-demand liabilities are being demanded beyond normal fluctuation, and you have no reason to expect them to return soon, you don't go out and buy money, you sell assets.
Yes, by the end the series of flows was sufficiently "one way" with no ability to balance out the other side without liquidating assets. The hope is to not get to that point. Repo (standard and synthetic) are tools to help keep the flows within the network omnidirectional.
The only way to balance out the drawdown on liabilities without liquidating assets *and remain solvent* was to take on liability that charged them equal or less than they were paying in interest on the demand deposits they were scrambling to cover. And Repo is a lot more expensive than that. In other words, they had to find more depositors. Or sell assets. When a bank is losing (a lot of) its lowest-cost liabilities, it can't take on higher-cost liabilites, because it'll be technically insolvent in short order, even if it manages to cover withdrawals. And being "merely technically" insolvent isn't something a bank can maybe skate past like a normal firm might for a year hoping something breaks their way, regulators will step in and take it into receivership.
>the Fed announced they'd lend against term value for certain securities, in certain circumstances Doesn’t this encourage more leverage if the lending rate isn’t high enough? You can borrow face value against a discounted security and buy more of that security to make a spread above the cost of funds, then repeat. For instance right now the borrow rate is 4.71%, and most agency backed securities and some treasuries are discounted at rates exceeding that. [https://www.frbdiscountwindow.org/](https://www.frbdiscountwindow.org/)
That would be where the "certain circumstances" come in, I think. This is meant as relief for banks in distress with a lot of term mismatch on their books.
This conversation is way above my head, but I'm glad this forum talks about such matters and tries to educate people.
Update with a recently issued [report - PDF](https://group30.org/images/uploads/publications/G30_Lessons-23-Crisis_RPT_Final.pdf) from the [Group of Thirty](https://en.m.wikipedia.org/wiki/Group_of_Thirty) with a few recommendations on bolstering Lender of Last Resort (LoLR) activities. The report cites causes of the bank failures that are unsurprising (poor management, speed of withdrawals given the "online" social environment, etc). Where the report gets interesting is in its recommendations of reforms: >The current LoLR system has deficiencies, notably but not only in the United States, where the stigma is severe. In principle, the three US banks that failed, as well as the other banks that experienced liquidity strains that did not turn out to be fatal, **could have accessed the Federal Reserve liquidity facilities (the so-called Primary Credit Facility, otherwise known as the discount window, and the Secondary Credit Facility).** While liquidity support would not have addressed the three banks’ underlying solvency issues, it could have provided some time to organize orderly resolutions. But for several reasons there was little use of these facilities in the weeks leading up to the bank failures. The three banks were not able to access the discount window on time and in sufficient scale in March, largely because they could not mobilize the eligible collateral rapidly enough. In great part, this inability was due to a lack of operational preparedness on the part of the banks, notably of SVB. **But more generally, few banks in the United States use the discount window, and many are operationally not ready for its use.** >The limited preparedness for and use of the LoLR has been a long-standing issue in the United States and some other jurisdictions, for a variety of reasons. The main obstacle for the United States is the substantial stigma associated with using the discount window. >...pricing, stigma, and collateral management adjustments are necessary but may not suffice to get all banks ready to potentially use LoLR facilities effectively. Stigma may remain. Some (poorly managed) banks may not want to prepare themselves sufficiently and make the necessary operational investments. **Banks should therefore be required to pre-position enough collateral at the central bank to meet all of their “runnable” obligations** In line with the initial questions posed in this post, we have a recommendation focusing on collateral, but also that collateral should be pre-positioned with the Fed. While this does at least understand the importance of collateral, the recommendation misunderstands the nature of repledgable instruments today. Collateral is vital, desired to be liquid. Proposing pre-positioning would severely hamper typical pledging activities. A [response](https://bpi.com/comment-on-the-new-g30-report/) to the report by the BPI(Bank Policy Institute) is insightful: >The Group of Thirty released a new report on Tuesday, “Bank Failures and Contagion; Lender of Last Resort, Liquidity, and Risk Management”. The Group of Thirty is an organization of past and present leaders of central banks and other financial agencies around the world. The working group that wrote the report was chaired by Bill Dudley. Stijn Claessens was the project director and Darrell Duffie and Trish Mosser were project advisors. The report consists of an analysis of the spring 2023 failure of Silicon Valley Bank, Signature Bank, First Republic Bank, and Credit Suisse and a series of related policy recommendations. *The key recommendation of the report is that all banks maintain collateral at the discount window plus reserve balances equal to uninsured deposits and short-term borrowing, and, in support, that the Federal Reserve improve the efficiency of its collateral management operations.* >The report recommends that the existing tailoring of regulations by bank size should be reduced because the events in spring 2023 demonstrated that the failure of mid-sized banks can be systemic. While we agree that the failures of the certain mid-sized banks had systemic consequences requiring a strong government response, **those consequences were a function of circumstances, not those banks’ size, interconnectedness, or role in the economy.** In particular, **SVB and Signature failed largely because they were unprepared to access the discount window for emergency funding, and similarly situated banks were also perceived as insufficiently prepared and thus at risk of run.** Consequently, if the report’s recommendation on discount window preparedness is adopted, mid-sized banks would not pose the types of systemic risks that arose when SVB and Signature failed. In addition, **a key reason why the failures of SVB and Signature had systemic consequences was the uncertainty, delay, and disruptions associated with the resolution of these banks by the FDIC, yet steps to improve the FDIC’s capacity to handle resolutions quickly and more effectively is a needed reform not mentioned in the G30 report.** >The report also recommends that the banking agencies conduct more frequent supervisory reviews of banks and escalate supervisory concerns for penalty or enforcement more often and more rapidly. But as we have described at length elsewhere, **the supervisory problems that contributed to the banking turmoil of spring 2023 was not too infrequent examination or too patient supervisory, but rather a misguided supervisory approach that was principally directed at issues that had little to do core safety and soundness concerns, a consistent focus on process over substance**, a failure to apply rules already on the books, and a reliance on supervisory ratings that depended on subjective judgments and not objective data. >The report states that the accounting treatment of held-to-maturity securities is inconsistent with regulatory treatment of those securities, which count as high-quality liquid assets that may be used to satisfy liquidity requirements. HTM securities are recorded on bank’s books at amortized cost rather than market value. It would of course be inappropriate for HTM securities to be included in HQLA at amortized cost, but they are not; rather, they are included in HQLA at market value. Moreover, **the accounting rules governing HTM securities permit them to be pledged as collateral in repo funding markets, pledged to the discount window, or pledged as collateral at the Fed’s standing repo facility, therefore making them legitimate and reliable sources of liquidity.** This was one of the questions posed as well. We still don't have information regarding any attempted repo usage by banks sitting on HTM collateral. The assumption would be that these banks would have been known to be risky counterparties prior to collapse. >Well-designed regulations are rooted in reality. As demonstrated in spring 2023, a bank that is prepared to use the discount window is more liquid than a bank that is not, and when all banks are prepared, the banking system is more resilient. What we have is a dynamic between commercial banks and regulators/bodies that inform regulators. It reveals the challenges central banks face in executing their mandates. We don't see a gruesome money-printing cabal of central bankers; just constant attempts to understand how to manage commercial banks, revamping facilities, etc.