What the hell is Bank Term Funding Program?
What the hell is Bank Term Funding Program?
The program to solve SVB crisis has made waves over last week. Experts are confused if it is a bailout / QE/Money Printing/ Inflationary / Deflationary etc. I read the fine print. Here is the deal!
Faced with SVB failure, the policy response to create the Bank Term Funding Program was different from the Fed discount window.
What is Bank Term Funding Program?
BTFP was created “to provide liquidity to U.S. depository institutions, each Federal Reserve Bank would make advances to eligible borrowers, taking as collateral certain types of securities’.
US Fed issued a 1-page short release accompanied by a term sheet for BTFP and a detailed FAQ.
In effect the BTFP allows banks to get advances from Fed directly:
of an amount equal to the collateral pledged
collateral valued at par, but only certain high-quality collateral qualifies - basically, treasuries and Mortgage Bonds (guaranteed ones)
paying interest rates of ~4.5% fixed (one-year overnight index swap rate plus 10 basis points)
for a period of up to 1 year.
This is different from the Fed discount window. The Fed discount window, called Primary Credit, allows banks to get amounts for a particular variable time and variable interest rates set by the Fed; the collateral is valued at market prices and further discounts.
What does this mean?
To answer some basic questions:
Is it Quantitative Easing?
During Quantitative Easing, QE, the Fed purchased various securities from the banks. The BTFP is not a purchase. Hence it is not QE.
Is it money creation?
It is not money creation. It locks in an equal amount of assets. Thus there is no money created in the system. It creates liquidity in the availing bank's balance sheet.
Is it inflationary or deflationary?
Since BTFP advances are not creating money, they will not be inflationary.
Is this a bailout?
This question is misdirected. BTFP is indeed a bailout but only for depositors. So to a certain extent, Fed, Treasury and FDIC are not in bad books yet.
But there are more complex effects.
Effect on Bank availing BTFP
We may think of BTFP advance as a deposit into the bank. It will sit on the liability side of the balance sheet. In a way, the Fed is replacing depositors in the bank's balance sheet at ~4.5% interest rate.
The cost of BTFP funds at the moment is around 4.5%. This changes as the Fed benchmark rates change. But at the moment, it is at ~4.5%. This interest cost for BTFP deposit is higher than the interest rates paid to depositors (usually ~2%). Thus, banks' interest costs will INCREASE.
The bank’s Interest Income depends on the loan book size and whether it can pass on the higher interest costs to its clients in the current environment.
The bank will benefit from near-term liquidity, but that benefit will come at the cost of a long-term margin contraction. It imposes penalties on the bank for its bad behaviour.
Why not use the FDIC restructuring?
As mentioned in my previous post, the alternative to BTFP was a restructuring under the Federal Deposit Insurance Scheme (FDIC).
In this case, the government only protects the depositors through Federal Deposit Insurance Corporation (FDIC). FDIC secures deposits up to $250,000 per account. For amounts higher than $250K, FDIC issues a receivership certificate. Once the banks’ assets are sold, whatever money is recovered is divided between secured and unsecured creditors and those holding receivership certificates.
This restructuring has some issues.
The liquidation of assets takes time, and recovery depends upon the market conditions. Under normal market situations, this is quick. But it still takes anywhere between 6 to 24+ months.
In a market where there are many such institutions (god only knows why!), the FDIC process will lock up part of the market leading to contagion effects.
Further, in complicated situations like now, the liquidation process distorts market prices.
Finally, we cannot rule out the political considerations that the high-value depositors were major donors of the ruling party.
In Sum
BTFP is designed to help depositors while imposing a penalty on the bank for their mismanagement. In general, the central banking system was created to avoid depositors getting penalised for bad bank behaviour. So the Fed was acting within the mandate to save the depositors. The question is to what extent the depositors should be saved. It is not an easy question to answer.
But it has resulted in tighter credit conditions and stricter lending standards. Both of these could bring the economy down. We will see how in the next post.