Bank Term Funding Program (BTFP) Ends | Should Banks Be Worried?
On January 24, 2024, the Federal Reserve Board delivered a significant announcement that sent ripples across the financial landscape: the Bank Term Funding Program (BTFP) would cease making new loans as scheduled on March 11, 2024. The BTFP, which was established to bolster American businesses and households by providing additional funding to eligible depository institutions, has been a crucial lifeline for banks in meeting the diverse needs of their depositors. However, with its imminent closure, concerns loom over the potential strain this could place on banks, businesses, and individuals, posing a threat to the overall economy.
Understanding the Bank Term Funding Program (BTFP)
In March 2023, the financial sector was shaken by unexpected bank failures affecting Signature Bank and Silicon Valley Bank. The rapid rise in interest rates, triggered by inflationary pressures, caused usually secure investments in U.S. Treasury securities to lose value, prompting both banks to sell bonds at a loss to meet customer withdrawal demands. As panic spread, the Federal Deposit Insurance Corp. (FDIC) and the Federal Reserve intervened to stabilize the situation. However, the FDIC's $250,000 insurance limit per customer per institution left many account holders at the failed banks with significant losses. To address the liquidity crisis, the Federal Reserve established the Bank Term Funding Program (BTFP), offering cash advances to eligible borrowers secured by specified securities, including those available in open market operations, such as U.S. depository institutions, credit unions, and branches of foreign banks.
The BTFP, initiated by the Federal Reserve Board on March 12, 2023, aimed to address liquidity challenges faced by American financial institutions. It offered loans of up to one year to various eligible entities, including banks, savings associations, and credit unions. These loans were secured against high-quality collateral such as U.S. Treasuries, agency debt, and mortgage-backed securities, providing institutions with an additional source of liquidity during times of financial stress.
Key Components of the BTFP
BTFP was designed to bolster liquidity and fortify the stability of the banking sector during times of uncertainty. Here's a breakdown of the key elements that define the structure and functionality of the BTFP:
Borrower Eligibility:
Any U.S. federally insured depository institution or U.S. branch/agency of a foreign bank eligible for primary credit was eligible to participate.
Eligible Collateral:
Collateral included securities eligible for purchase by the Federal Reserve Banks in open market operations, provided they were owned by the borrower as of March 12, 2023.
Advance Size:
Limited to the value of eligible collateral pledged by the borrower.
Rate:
Determined by the one-year overnight index swap rate plus 10 basis points, ensuring the rate remained above the IORB rate in effect on the day of the advance.
Collateral Valuation:
Valued at par, with a margin of 100%.
Advance Term:
Up to one year, with no associated fees and the option for prepayment without penalty.
Credit Protection:
The Department of the Treasury provided the Federal Reserve Banks $25 billion in credit protection.
Recourse:
Advances were made with recourse beyond the pledged collateral to the eligible borrower.
Implications of Closure
The end of the BTFP raises concerns about banks' future liquidity and ability to meet depositors' demands. Since last spring, Banks capitalized on the opportunity provided by the BTFP, leveraging undervalued bonds as collateral to borrow funds at a comparatively low-interest rate. By depositing these funds into their reserve accounts at the Fed, they earned a higher interest rate than the one they were paying on the loan, benefiting from the program's financial incentives.
The program's closure could exacerbate their economic strains, hindering growth prospects and stability.
As the Bank Term Funding Program draws to a close, its impact on the financial landscape cannot be understated. While it served as a crucial support system for American businesses and households, its closure signifies a shift in the financial dynamics. As we navigate the aftermath, stakeholders must remain vigilant and explore alternative avenues like precious metals to sustain liquidity and protect their purchasing power.
