Banks warily warm up to Fed repo backstop By Reuters

By Paritosh Bansal

(Reuters) – Banks are finally signing up for a U.S. Federal Reserve funding backstop that has been lying nearly dormant for more than two years, putting them in a stronger position to deal with any stress. But it is unclear whether they will want to use it in a crisis.

The Standing Repo Facility allows banks to borrow emergency overnight cash from the Fed through a repurchase agreement, or repo, using Treasury and agency mortgage securities as collateral. Firms that act as the New York Fed’s trading counterparties, called primary dealers, have access, but other banks have to apply for it.

The backstop was set up in July 2021 to support money markets after interest rate spikes there led to worries about financial stability. Banks have been slow on the uptake.

Some market participants and researchers said the reluctance stemmed in part from worries that a stigma might be attached to it, as borrowing from the Fed in a crisis could be seen by investors and bank examiners as a sign of liquidity issues or other problems.

With investors selling first and asking questions later – as regional U.S. banks were reminded recently after New York Community Bancorp (NYSE:)’s troubles – any sign of weakness can quickly snowball to a crisis of confidence in the lender.

While that apprehension persists in some quarters, interviews with two of the market experts and a recent Fed survey show banks are signing up for the facility.

That’s because in the wake of the bank runs last March regulators have been pushing lenders to make sure they are prepared to deal with any deposit outflows in the future, said Bill Nelson, chief economist at the think-tank Bank Policy Institute.

Other market experts also pointed to growing concerns that liquidity could get scarce in the coming months as the Fed drains hundreds of billions of dollars of excess cash from the financial system as it removes pandemic-era stimulus.

In his conversations with banks over the past couple of months, Nelson said he had found that many were signing up.

“The latest indications are that it’s getting greater acceptance and interest,” said Nelson, who flagged bankers’ worries about the repo facility two years ago.

So far seven U.S. regional banks have signed up – all after the March bank collapses.

Overall, 26 banks, many of them affiliates of primary dealers, are currently counterparties. Together, they account for roughly two-thirds of all Treasury and agency securities held by banks, according to Reuters calculations, based on bank disclosures about their securities holdings.

First Citizens Bank is the most recent addition. John Moran, a spokesman, said the bank became a counterparty “to expand our monetization channels, including our repo facilities.”

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It is important both for their own sake and for the sake of financial stability that more banks become counterparties to the repo backstop — and, if needed, use it.

Funding can become scarce and costs rise quickly in times of stress, and ready-access to such a facility could determine whether a bank survives or fails.

Silicon Valley Bank, for example, was not prepared to access an emergency cash backstop, called the Fed’s discount window, which contributed to its failure. The discount window suffers from an even bigger negative perception problem, something regulators are trying to solve.

“It’s one more arrow in the quiver,” said Darrell Duffie, a Stanford University finance professor, referring to the repo facility. “And it might be less stigmatized” than the discount window.

A Fed poll last September showed 21 of 93 domestic and foreign banks surveyed expressed interest in signing up, while 39 said they didn’t want to.

Seven have been added since the survey was done, suggesting more are in the pipeline.

In the survey, banks cited “a need or preference for an additional contingent overnight liquidity source” as the top reason in favor of signing up for the facility. The strongest argument for them to not want to do it: the fact that the Fed discloses who the counterparties are.

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The idea of using the repo facility to provide banks emergency funding originated in discussions at the Fed in 2015-16 about how to remove the stigma around the discount window, said Nelson, who worked at the central bank at the time.

Primary dealers did not face such an issue in conducting repo trades — in which the borrower agrees to buy back the collateral — with the Fed. The idea was to “repackage the discount window to look more and feel more like a repo,” Nelson said.

The facility was set up as a permanent feature a few years later, following money market problems during the pandemic in March 2020 as well as in September 2019, when the Fed removed too much cash from the system.

The backstop has not had to be used in a crisis yet, but the market participants said a pall hangs over it.

One of the sources, a top banking executive, said the industry worried about the prospect of being criticized by politicians for taking money from the government.

The executive said banks periodically talked about using it as an industry to show there is no stigma, but “at the end of the day, you know, there’s a stigma because you are taking money.”