(Reuters) -The Federal Reserve on Sunday unveiled a new program to ensure banks can meet the needs of all their depositors amid escalating chances of bank runs following the abrupt collapse of two major banks in the space of 72 hours.
The Bank Term Funding Program (BTFP) will offer loans with maturities of up to a year to banks, savings associations, credit unions and other eligible depository institutions.
Here are some key elements of the Fed’s program:
The Fed has raised rates from near zero a year ago to between 4.50-4.75% now to combat inflation that hit a 40-year high last year.
That has undercut bond prices, including those for older-vintage Treasuries held widely by banks, which proved a major factor in Silicon Valley Bank’s inability to raise funds and contributed to its demise. Officials worry others could soon follow.
“The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution’s need to quickly sell those securities in times of stress,” the Fed said in a statement on Sunday.
A key element of the program is acceptable loan collateral – including U.S. Treasuries and mortgage-backed securities among others – will be valued at “par,” meaning open-market bond values that have been impaired by a year of Fed rate hikes will not reduce what a bank may borrow from the central bank.
The same collateral terms will also be available for loans drawn from the Fed’s “discount window,” its traditional lender-of-last-resort facility. Ordinarily, loan amounts were governed by the market value of the pledged collateral.
“This will allow banks to fund potential deposit outflows Without crystalizing losses on depreciated securities,” Goldman Sachs wrote Sunday after the Fed announcement.
LOANS FOR A YEAR
Loans of up to a year in length will be available under the new facility. Borrowers may prepay the loans without penalty. Advances can be made until March 11, 2024.
FIXED BORROWING COST
Interest rates will be the one-year overnight index swap (OIS) rate plus 10 basis points and will be fixed for the term of the advance on the day the advance is made.
That OIS rate was quoted at about 4.9% late Sunday following the Fed’s announcement, according to Refinitiv data, down from as high as 5.6% last week before Silicon Valley’s difficulties emerged and started driving rates lower.
The loan commitments made by the Fed’s 12 regional banks will be backstopped with $25 billion from the U.S. Treasury’s Exchange Stabilization Fund. The Fed said it does not expect to have to tap those funds because the loans under the program are full recourse, meaning the central bank can seize all of the pledged collateral in the event of a failure to repay.
In fact, the Fed loans are made with “recourse beyond the pledged collateral,” which takes into account the fact that the collateral may be impaired.
That suggests “that the par valuation of the collateral would only become relevant if the borrowing institution lacks sufficient assets to repay the loan,” Goldman wrote.
“One of the biggest revelations about the failure of Silicon Valley Bank to raise capital last week was the impact of the cumulative increase in interest rates over the last year on their securities portfolios,” Jefferies economists wrote after the details were released.
“Because the pledged collateral is going to be valued at par, this new facility will ensure that other banks with similarly impaired hold-to-maturity portfolios will be able to easily leverage them to access liquidity, rather than have to realize significant losses and flood the markets with paper.”
“Monday will surely be a stressful day for many in the regional banking sector, but today’s action dramatically reduces the risk of further contagion,” they said.
(Reporting By Dan Burns; Editing by Sam Holmes)