Following the failure of Silicon Valley Bank and Signature Bank, banks requested unprecedented amounts of emergency liquidity from the Federal Reserve, which helped undo months of central bank efforts to reduce the size of its balance sheet, according to Fed data released on Thursday.

As of Wednesday, banks took loans totaling $11.9 billion from the Fed’s newly established Bank Term Lending Program and an all-time high $152.9 billion from the traditional lender-of-last resort facility known as the discount window. In the fall of 2008, at the height of the financial crisis, the discount window jump broke the previous record of $112 billion.

The central bank’s total balance sheet exploded by about $300 billion in the previous week, including more than $140 billion in additional funding given to the new bridge banks for Silicon Valley Bank and Signature Bank established by the Federal Deposit Insurance Corp. That effectively undoes the majority of the balance sheet reduction made since last summer.

Despite the size of the borrowing, some analysts were encouraged by what they observed and stated that there is now less cause to worry that the recent events will escalate to the point where they will crash the entire economy.

“The numbers, as we see them right here, are more consistent with the idea that this is just an idiosyncratic issue at a handful of banks,” said Thomas Simons, money market economist with investment bank Jefferies. The government’s support efforts appear likely to work and the size of the numbers reported by the Fed Thursday suggest “it’s not like a huge system-wide problem,” he said.

The failure of the local financial institution Silicon Valley Bank on Friday and then the failure of Signature over the weekend shook the markets, which led to the Fed’s bank lending facility being introduced on Sunday.

The facility departs from other Fed lending initiatives that impose penalties on the lending by allowing a variety of banks and other eligible firms to borrow against Treasuries, mortgage back securities, and other eligible collateral at face value. The borrowing cost for businesses to do this for up to a year is the one-year overnight index swap rate plus 10 basis points.

A $25 billion guarantee from the Exchange Stabilization Fund of the Treasury Department underpins the bank lending facility.

It was somewhat unexpected that banks would gravitate toward the new lending facility rather than the record discount window borrowing. However, there was also a timing issue because the discount window was open when the problems started, so firms might have used it first. Some people hypothesized that eventually, the money might switch from the discount window to the new facility.

Nevertheless, some considered the increase in discount window borrowing positive on its own. For a long time, eligible banks avoided using the facility out of concern that doing so would reveal their financial difficulties to other businesses in the market. To questionable success, the Fed has made an effort to remove this stigma.

According to Thursday’s figures, Steven Kelly, senior research associate at the Yale Program on Financial Stability, feels that the extraordinary action of establishing a new facility may not even have been necessary.

According to the Fed’s numbers, “what this tells me is how easily this could have been done through the discount window,” he said, using the Fed’s already-available toolkit.

The surge in emergency lending stopped the Fed’s balance sheet from contracting and instead made it significantly bigger.

The total amount held by the Fed fell to $8.39 trillion on March 8 before rising to nearly $8.7 trillion on Wednesday, the highest level since November, after peaking at just shy of $9 trillion last summer before it started to take steps to cut its holdings of Treasury and mortgage-backed bonds.

Two important pillars of monetary policy are brought into some degree of conflict by the renewed increase in the balance sheet at a time when the Fed is still expected to continue raising interest rates.

“That’s a feature, not a bug,” said Derek Tang of forecasting firm LH Meyer. The Fed will be able to stay the course on inflation-fighting rate rises and a bigger balance sheet will allow it to also stay the current course on shedding bonds and avoid stopping altogether the balance sheet run down, he said.

(Adapted from BusinessToday.in)

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