The Discount Window Enhancement Act of 2024 would improve the effectiveness of the Federal Reserve Discount Window, a liquidity tool that provides short-term loans to depository institutions.
Depository institutions include commercial and community banks, and the legislation would help reduce the fallout of bank failures fueled by panic-induced bank runs.
U.S. Sen. Mark R. Warner of Virginia, a member of the Senate Committee on Banking, Housing, and Urban Affairs, introduced the legislation in late July in the wake of multiple bank failures in 2023, including the collapse of Silicon Valley Bank. He voiced the need for legislation to improve the function of the Fed’s Discount Window.
“The failures of Silicon Valley Bank and Signature Bank last year highlighted the urgent need to reform the Federal Reserve’s discount window for the 21st century economy, where bank runs can occur over hours, rather than days. My legislation will implement key reforms to make sure that banks can actually use the discount window, reduce the unnecessary stigma associated with that use, and improve the window’s operations to meet the challenges of the digital age. We need to modernize the window and return this important liquidity tool to its intended role,” Warner said.
The Discount Window Enhancement Act of 2024 will:
· Mandate Testing of the Discount Window: Mandates that eligible depository institutions operating in the United States engage in test borrowing at the Federal Reserve’s Discount Window:
o Large Institutions (> $100 Billion): Quarterly.
o Smaller and Larger Institutions ($10 Billion – $100 Billion): Semi-annual.
o Small Institutions (Under $10 Billion): Not in scope.
· Require Regulators to Reflect Banks’ Ability to Use the Discount Window in Liquidity Evaluations: Regulators must “give credit” in their evaluations of bank liquidity preparedness to depositories that can use the discount window successfully – “positive consideration” must be given to successful testing and pre-pledged collateral;
· Require Financial Institution Risk Committees or Equivalent to Review and Approve Liquidity Contingency Plans: Depositories’ liquidity contingency plans are to include detailed policies and procedures for seeking advances and be submitted to Federal Reserve Board, Regional Federal Reserve Bank of membership, and primary supervisor;
· Require the Federal Reserve Board to Modernize Discount Window Operations;
· Require the Federal Reserve System to Simplify and Harmonize Collateral Processes with Federal Home Loan Bank System: The Federal Reserve Board must work with the FHFA and the FHLB system to simplify and harmonize policies and procedures for pledging and transferring collateral among FHLBs and Federal Reserve Banks.
· Require Review of Weekly Federal Reserve Balance Sheet Reporting: The Federal Reserve Board must comprehensively review the weekly reporting of its balance sheet activities, and consider changes to avoid market distortions that could inadvertently place individual financial institutions at a disadvantage.
· Require Federal Reserve Study and Report to Congress on Discount Window Stigma: Requires the Federal Reserve Board to conduct a study and submit a report to Congress about additional measures that could be taken to reduce discount window stigma and improve the process for obtaining advances on behalf of depository institutions.
Warner has led efforts to hold individuals responsible for bank failures accountable. In the aftermath of the Silicon Valley Bank collapse, he cosponsored the DEPOSIT Act, the Bank Management Accountability Act and the Failed Bank Executives Clawback Act, efforts to ensure that bank executives do not profit in the wake of bank failures.
“As evident from events in March 2023, it is clear that the current discount window mechanism at the Federal Reserve has deficiencies that have led to severe stigma, increasing the risk of banking panics and deposit runs. This bill will provide a good basis for regulators to implement operational improvements and reduce frictions that hinder the effectiveness of discount window,” said William C. Dudley, Former President of the Federal Reserve Bank of New York.
Hal S. Scott, Nomura Professor and Director of the Program on International Financial Systems at Harvard Law School; Director of the Committee on Capital Markets Regulation, said the banking crisis last year and the COVID-19 pandemic in 2020 revealed vulnerabilities.
“The events of March 2023 in particular showed that bank runs can occur faster than they did in the past. To illustrate this point: SVB experienced a total outflow of 25% of deposits in one day. Given this, what is needed is an operational system that allows the transfer of collateral and funds at the push of a button. At the same time, it is also imperative that the Federal Reserve maintain its independence as a liquidity provider to banks, given its clear mandate under Section 10B to act independently. This bill is a foundation in which regulators can build off of to bring the discount window into the 21st century,” Scott said.
Steven Kelly, Associate Director of Research at the Yale Program on Financial Stability, said the legislation raises the bar on discount window effectiveness for banks, regulators and supervisors.
“The bill makes clear that the default supervisory assumption should no longer be to assign zero value to the approximately $3 trillion of collateral already prepositioned at the Federal Reserve—an amount set to continue to grow, particularly under the direction of this bill. Importantly, the bill also calls for examination of the Fed’s current practice of publishing district-by-district activity, which risks ‘outing’ a bank’s discount window borrowing on a weekly basis—as opposed to only after a two-year lag as legislated under the Dodd-Frank Act,” Kelly said.
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Rebecca Barnabi
