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Source: Barchart

Source: Reuters

Banks that borrowed from a Federal Reserve (Fed) emergency lending facility crafted after the collapse of Silicon Valley Bank might start repaying their loans at a faster pace, draining liquidity from the financial system. 

The Bank Term Funding Program, or BTFP, launched in 2023 to support ailing financial institutions and restore confidence by allowing banks and credits unions to borrow money for as long as a year at low costs was a popular programme, surging to an all-time high of US$168 billion (RM696.86 billion) earlier this year. But now that the Fed slashed rates by a half-percentage point the lending, facility is looking less attractive, according to RBC Capital Markets strategist Izaac Brook. 

“We might see early repayment of these loans start to ramp up in the coming weeks,” Brook wrote in a note to clients . “If not, these BTFP loans should largely roll off around year-end, given that most were either originated, or rolled over for another year, before the programme was made less attractive in Jan ‘24.” 

Financial institutions tapped BTFP to take advantage of loans carrying generous terms: one-year overnight index swap rate plus 10 basis points with no penalty for early repayment, and US Treasuries and agency debt as collateral valued at par. 

The facility was so attractive that Fed policymakers increased the cost of borrowing in January because some institutions were taking advantage of it to fund an arbitrage opportunity. As a result, borrowing from the programme shrank. 

If loans are largely repaid, liquidity will be removed from money markets. Whether the money will come from the Fed’s overnight reverse repurchase agreement facility or bank reserves will depend on whether banks rely on borrowing from the federal home loan banks or money-market funds pulling cash from the RRP to absorb the increased supply. 

Banks of course could turn to other sources like commercial paper or certificates of deposit, or they could just let the loan roll off without seeking alternate financing.

Brook sees borrowing from the FHLB as the most likely path given that many of the banks that tapped the BTFP are smaller and have limited access to funding. He also said it’s unlikely institutions will turn to other Fed facilities like the discount window or standing repo facility unless they were experiencing severe stress. 

While repayments are expected to create some funding pressure in the short term, it will have little impact on the central bank’s plan to reduce its bond holdings or unwind its balance sheet.

“These pressures would be transitory and not meaningful enough to threaten an early end to QT,” Brook said, referring to a process known as quantitative tightening. His firm doesn’t expect QT to end until the second half of 2025. 

Source: Theedgemarkets