Banks that borrowed from the Federal Reserve's emergency loan facility following the collapse of Silicon Valley Bank may begin to repay the loans at a faster pace, thereby draining liquidity from the financial system.
The Bank Term Funding Program (BTFP), launched in 2023, was designed to support distressed financial institutions and restore confidence by allowing banks and credit unions to borrow funds at low cost for up to one year. The program was widely popular and had surged to a historic high of $168 billion earlier this year.
However, RBC Capital Markets strategist Izaac Brook noted that the program has become less attractive after the Fed's 50 basis point rate cut. "We may see an increase in prepayments of these loans in the coming weeks," said Izaac Brook. "If not, these BTFP loans should mature around year-end, as most were either issued before the program's appeal declined in January 2024 or rolled over for another year."
Financial institutions took advantage of the BTFP's very favorable loan terms, including a one-year overnight index swap rate plus 10 basis points, no penalties for early repayment, and collateral in the form of U.S. Treasury and agency debt (at par value). The tool was so attractive that Fed policymakers increased borrowing costs in January, as some institutions were using the tool to fund arbitrage opportunities. As a result, loans from the program have declined. The latest data shows that as of the week ending September 18, the size of the program dropped to $94.8 billion.
Advertisement
If most of the loans are repaid, liquidity will be withdrawn from the money market. Whether these funds come from the Fed's overnight reverse repurchase agreement (RRP) facility or from bank reserves will depend on whether banks rely on borrowing from the Federal Home Loan Banks or on money market funds to draw cash from the RRP to absorb the increased supply. Banks can, of course, turn to other channels, such as commercial paper or certificates of deposit, or simply roll over the loans without seeking other financing channels.
Izaac Brook believes that borrowing from the Federal Home Loan Banks is the most likely route, as many banks that utilized the BTFP are smaller and have limited financing channels. He also said that financial institutions are unlikely to turn to the Fed's other tools, such as the discount window or standing repo facility, unless they face severe stress.
Although repayments are expected to cause some short-term financing pressures, they are unlikely to significantly impact the Fed's plans to reduce bond holdings or clean up its balance sheet. "These pressures will be temporary and not severe enough to threaten an early end to quantitative tightening (QT)," said Izaac Brook, who expects QT to end in the second half of 2025.
Leave A Reply