The Federal Reserve suddenly took action: raised the interest rate of the bank's term financing program
Finance Associated Press, January 25 (Editor Xiaoxiang) Last year, the emergency financing tool launched to bail out the banking industry, the Bank Term Financing Program (BTFP), has now become an "arbitrage paradise" for many institutions in anticipation of interest rate cuts......
The Federal Reserve announced on its official website on Wednesday local time that from now on, the adjusted BTFP interest rate will be "not lower than" the interest rate on the reserve balance in effect on the day the loan is issued.
The Federal Reserve's bank term funding program was introduced to ease stress in the financial system during last year's regional banking crisis triggered by the Silicon Valley Bank collapse — allowing banks and credit unions to borrow money at face value against U.S. Treasuries and agency bonds for a term of up to one year.
Prior to Wednesday's latest change, the BTFP rate was a one-year overnight index swap (OIS) + 10 basis points. According to Wednesday's quote, the BTFP rate for that day is about 4.88%. By comparison, the reserve rate is currently around 5.4% – which typically moves in tandem with the Fed's benchmark federal funds rate target.
This means that financial institutions can enjoy risk-free arbitrage of more than 50 basis points by borrowing funds through the BTFP program and then placing them in reserve balances. After Wednesday's adjustment, the BTFP rate will be raised by at least more than 50 basis points, and there is no room for arbitrage.
In its statement, the Fed said that "the adjustment of interest rates for the bank's term funding program is to ensure continued support for the program's objectives in the current interest rate environment." The Fed added that the terms of other programs have not changed.
It is worth mentioning that the Federal Reserve also announced this time, as expected by the market, that this temporary tool will end on March 11 as originally planned, and stop issuing new loans. Earlier this month, senior Fed officials briefed that the program would not be extended beyond the March 11 deadline.
The Fed is no longer willing to sit back and watch an "arbitrage paradise" grow
In fact, since the end of last year, there have been constant doubts that the Federal Reserve's banking bailout plan has become an "arbitrage tool" for financial institutions.
The agency found that borrowing cash through this newer lending facility is cheaper than borrowing cash through the traditional discount window, which is currently at 5.5%, due to the sharp drop in OIS rates due to rising rate cut expectations. In the week to Jan. 17, banks had taken advantage of the discount window to just $2.3 billion, well below the all-time high of $153 billion set in March last year.
For banks, the drop in the BTFP rate also means greater arbitrage opportunities, as institutions can borrow from the instrument and then deposit the funds into their accounts with the Federal Reserve, easily earning the interest rate differential between the reserve rate.
Federal Reserve data shows that in the week ending Wednesday, January 17, the size of funds borrowed from BTFP has reached a record $162 billion. This comes from an all-time high of $147 billion, just the week before.
Commenting on the move, Steven Kelly, associate director of research at Yale University's Financial Stability Program, said, "This [the Fed's latest move] doesn't surprise me, given the negative public opinion and real arbitrage behavior." The Fed doesn't want to 'print money' for banks in this way. They won't wait until March. ”
Fed officials, including Federal Reserve Vice Chair Barr, who oversees financial regulation, and New York Fed President Williams have previously said the BTFP is a response to an "emergency" to provide liquidity in a pinch.
The Fed has long used the discount window as a long-term alternative to meeting such liquidity needs.
In its press release, the Fed said that during the tense period last spring, the bank term funding program helped ensure the stability of the banking system and provided support to the economy. After March 11, banks and other depository institutions will continue to be readily available to meet liquidity needs through the discount window.
(Finance Associated Press Xiaoxiang)