The Stigma of the Fed’s Discount Window Persists in the Post-Crisis Era

The New York Federal Reserve Bank published a comprehensive analysis regarding the stigma associated with the Federal Reserve's Discount Window (DW) from 2014 to 2024. The report shows that stigma persists, particularly among small banks and during periods of financial distress, despite policy changes aimed at encouraging its use. The study highlights that the reluctance to utilize the DW, seen as a lender of last resort, was notable even months before the banking turmoil in 2023 and continued a year later.

The DW provides backup financing to sound depository institutions against various types of collateral. Over the years, the Fed has modified DW policies to promote borrowing and reduce stigma. Notably, at the onset of the COVID-19 pandemic in 2020, the Fed lowered the primary credit rate to 0.25% and extended loan maturities to 90 days, among other changes. Nevertheless, stigma has not been entirely eliminated.

The report details that small domestic banks with less than $50 billion in assets paid an additional $0.5 billion in interest by borrowing federal funds at rates above the DW rate during the year following the failure of First Republic Bank on May 31, 2023. This occurred even as liquidity markets appeared to normalize, indicating that stigma remains a more costly and persistent issue for smaller institutions.

Analysis reveals that a bank experiencing stigma has approximately a 40% higher likelihood of facing stigma again the following month. Additionally, banks that visit the DW are less affected by subsequent stigma. Financial weakness also increases a bank's sensitivity to stigma, which tends to be a stronger indicator of a bank's risk of failure than DW borrowing.

The study also examined DW borrowing patterns post-2014, noting that pre-COVID-19, DW activity was minimal but reached a record level of $49.8 billion during the pandemic. The March 2023 banking turmoil saw a further substantial increase in DW borrowing, with outstanding amounts reaching $155 billion, significantly higher than at the onset of the global financial crisis or the pandemic.

Evidence of DW stigma was not limited to the federal funds market; it was also present in other funding markets. The report suggests that stigma was visible around the last three major financial disruptions: the September 2019 repo market disruption, the onset of the COVID-19 pandemic, and the March 2023 banking turmoil.

The New York Fed's findings indicate the complexity of addressing DW stigma and raise questions about the effectiveness of current policies. The continued stigma, especially among small banks, suggests significant challenges to the Fed's goal of promoting regular DW access "in good times and bad." The report concludes that further research is needed to understand why stigma persists and how reforms can be effectively implemented to encourage the use of the DW without associated stigma.