The BFD with the BTFP
#71: With six months left in the Bank Term Funding Program, which banks are using the facility, what happens when it expires, and is it a big deal?
Created on March 12, 2023 in response to Silicon Valley Bank’s failure, the Bank Term Funding Program’s (BTFP) one-year life is already halfway gone. With $108 billion of loans currently outstanding from the Fed to cash-strapped banks, it’s reasonable to wonder what happens when the facility expires.
But considering the BTFP in isolation is like analyzing the knobs of a single jigsaw puzzle piece — neither elucidating nor interesting. To better understand the impact of the BTFP, we need to consider the whole puzzle.
At the heart of the issue, monetary policy has caused dramatic swings in the liquidity in the banking system. Under this stress, some banks have failed and others have turned to the Fed for support. While the BTFP has provided temporary liquidity to the market, it eventually must be replaced with more permanent financing from within the banking sector.
Today we consider:
How monetary policy influences liquidity in the banking sector
The terms of the BTFP and which banks are using it
How loans may be repaid when the BTFP expires
Let’s first establish the key factors impacting bank liquidity, and how they have evolved over the past several years.
There are two key dynamics to consider; the internal distribution of liquidity within the banking system as well as the aggregate liquidity driven by monetary policy.
Internal Distribution: Cash is constantly circulating amongst banks. While these flows will affect the cash position of any given bank, the aggregate cash in the system doesn’t change. Individual banks have some but not total control over their liquidity position. Critically, they cannot control their depositors’ requests for withdrawals. If a bank runs low on funds, there are many different methods by which they can draw cash from other banks within the system.
Aggregate Liquidity: Meanwhile, the aggregate liquidity available in the banking sector is driven by flows to and from the Federal Reserve - a product of monetary policy (and to a lesser extent fiscal policy). For this article, let’s ignore fiscal flows and focus only on monetary aspects. There are three broad levers of monetary policy which impact aggregate liquidity in the banking sector:
System Open Market Account (SOMA): The Fed can expand the pool of liquidity by buying bonds with new cash (quantitative easing) and reduce aggregate liquidity by letting those bonds mature (quantitative tightening). QE is expansionary policy while QT is tightening policy, determined at the sole discretion of the Fed.
Reverse Repo: The reverse repo facility (RRP) is the forcing mechanism that keeps short-term interest rates at the Fed’s target. To the extent that overnight market rates are below the RRP award rate, the RRP will draw cash out of the banking sector. If market rates exceed the RRP award rate, the RRP will provide cash to the banking sector. While the Fed sets the RRP award rate, the actual cash flow is determined by the market.
Lending Facilities: Finally, to ensure financial stability, the Fed backstops the banking sector by providing loans to the banking sector when needed through a number of facilities including the discount window (primary credit) and the BTFP. If a bank cannot find cash from within the banking sector, it can look to the Fed as a lender of last resort, which also increases aggregate liquidity.
The banking sector itself is made up of >4,000 banks and savings institutions that form the nucleus of the financial system. Everything else, including non-bank financial institutions, is built on the foundation of the banking sector and transacts in the form of bank deposits.
Since the start of the pandemic, monetary policy has created a massive whiplash in banking sector liquidity. This effect has been most pronounced at smaller banks, which are not subject to the same regulatory requirements as large banks.
First, the Fed injected enormous sums of cash into the banking sector, expanding the SOMA portfolio via QE. Banks were swimming in cash far in excess of what they needed or wanted. Cash assets at small banks tripled from early 2020 to late 2021.
Then, as the Fed pivoted to contractionary policy in 2022, these flows reversed. Aggregate liquidity was drained both through QT and the RRP. Eventually, liquidity pressure contributed to the failure of Silicon Valley Bank, and banks turned to the Fed’s lending facilities, including the new BTFP, to access liquidity.
Today, we are in an usual tug-of-war where QT is removing cash while the Fed’s lending facilities are providing liquidity. (Based on current rates, the flow of the RRP has also reversed and is now providing liquidity).
Yet, the BTFP only made up a portion of the Fed’s total lending. At its peak, new borrowings from the Fed injected $400 billion of liquidity to the banking sector which was included primary credit (the discount window), other credit extensions (Fed bridge loans to failed banks, backstopped by the FDIC), repurchase agreements, in addition to the BTFP facility.
When considering all of these categories, the total emergency lending outstanding has shrunk considerably since March, even as the balance of the BTFP facility has grown.
Nevertheless, usage of the BTFP continues to creep upwards reaching $108 billion today. This liquidity will eventually need to be returned to the Fed, and the banks that are currently utilizing the facility will need to find new financing from within the banking sector.
Let’s look closer at the BTFP.
The BTFP was established to provide unique and advantageous lending to banks against their securities portfolio. Banks can borrow against their security portfolios at par value rather market value in order to avoid a SVB repeat, where a bank strapped for cash is forced to sell bonds for a loss, impairing its capital position.
BTFP advances are fixed-rate loans (one-year OIS swap + 10bps) with a term of 1-year.
Importantly, while the facility itself closes on March 11, 2024, it does not mean that outstanding borrowing comes due on that date. The loans are due one year after they are extended, which means that loans taken just before the window closes could stay outstanding until March 2025. Ironically, this could incentivize usage of the facility over the next six months as banks look to extend their liquidity runways.
Further, because there are no prepayment penalties, there is nothing stopping a bank from refinancing their outstanding loans under the BTFP immediately before the facility expires and effectively extending the term for another year. Some CFOs have already suggested they are considering this approach1. In other words, there won’t be a $108 billion maturity wall in March 2024, which is good news.
So who is using the BTFP?