Thursday, Federal Reserve Bank of Cleveland President Loretta Mester said she supports taking more tangible efforts to prepare banks for a central bank liquidity facility to help them in times of stress.
At an event at Columbia University, Mester discussed possible Discount Window improvements as part of a broader discussion of the financial system and how regulators may improve it.
Mester said the Fed has been encouraging banks to establish liquidity agreements, collateral, and test the Discount Window, but doing so may be necessary.
“Testing at this time is not mandatory, but I support requiring such testing as part of sound liquidity management,” Mester said in her prepared remarks.
It is also worth considering asking banks to pre-position collateral at the window in proportion to their short-term runnable funding, including uninsured deposits, so they can borrow at the discount window if it runs.
Many banks avoid using the Discount Window because they fear it may alert other financial institutions to their problems. The Fed has fought to shed this taint.
The Fed added the Bank Term Funding Program to its lending arsenal a year ago when banks were struggling. The Discount Window has been mostly idle save for a lending burst, whereas the facility, which closes in March, has been heavily used.
Mester also warned that changes to how banks can borrow from the Federal Home Loan Banks might reduce a crucial liquidity source and push banks toward riskier funding sources, increasing the risk of liquidity issues in times of stress. "This increases the need for banks to be prepared to use the discount window as a source of contingency funding," said a source.
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