As the Federal Reserve took measures to prevent financial institutions from exploiting favorable terms, borrowing from a Federal Reserve emergency lending program surged to a new record. The Bank Term Funding Program (BTFP) witnessed demand climbing approximately $6.3 billion in the week through Wednesday, January 24, reaching an unprecedented high of $167.8 billion, according to Fed data. The increase, totaling more than $50 billion since mid-November, was propelled by the program’s interest rate falling below the rate at which institutions could profit by parking reserves at the Fed.
However, the risk-free arbitrage trade came to an end after the Fed’s late Wednesday announcement that the cost to borrow via the tool would immediately increase to “be no lower” than that for reserve balances. Prior to the adjustment, the BTFP borrowing rate was around 4.88%, representing a 52 basis points difference from the interest paid on reserve balances.
Ian Lyngen, Head of US Rates Strategy at BMO Capital Markets, remarked, “The Fed was right in the change it made. There was no sense for that mismatch to persist from a monetary policy perspective.”
The BTFP, launched during the banking crisis last year, allowed banks and credit unions to borrow funds for up to one year, using US Treasuries and agency debt as collateral valued at par. The borrowing rate was tied to market swap rates, which had decreased in recent months as traders anticipated monetary easing from the Fed.
In addition to the rate adjustment, the Fed confirmed that the BTFP will close as scheduled on March 11. Top central bank officials had signaled plans to shut down the program and cease new loans.
Despite the record demand for the BTFP, borrowing from the Fed’s discount window stood at $2.8 billion in the week ending January 24, significantly below the peak of $153 billion reached last March during the banking crisis.
Lou Crandall, Chief Economist at Wrightson ICAP LLC, stated in a note, “Our assumption is that new borrowing will fall essentially to zero in the new statement week beginning today.”
