Problems with Bank Term Funding Program (BTFP)

The Silicon Valley Bank crisis has prompted the Federal Reserve to evaluate its emergency funding program. The original emergency funding program i.e. the discount window was obviously not sufficient to provide funding to failing banks such as the Silicon Valley Bank. This is the reason that the bank ended up failing.

The Fed felt the need to create a different funding program that is tailored to the needs of the present situation. As a result, the Fed has created the Bank Term Funding Program (BFTP) in order to overcome the shortcomings of the discount window.

However, the Bank Term Funding Program (BFTP) seems to have certain shortcomings of its own. In this article, we will have a look at the shortcomings of the Bank Term Funding Program (BFTP) as well as how they impact the market and the economy in general.

  • Valuation of collateral: The biggest criticism being faced by the Bank Term Funding Program (BFTP) is that it values securities at par value instead of valuing them at market value. Hence, if a bank purchased a security at $100 but it is now valued at $50, the bank can still avail of a loan of $100 against that same security. This means that the Fed is taking in less collateral and giving out loans of a higher value. Obviously, this also means that the loan given by the Fed is partially unsecured.

    However, the Fed is only charging 10 basis points above the market rate as interest for the loan. This markup is very small considering the fact that the Fed is taking a huge risk by overvaluing the collateral. Also, this move by the Fed is unprecedented in any part of the world. Central banks have never overvalued collateral before. This is the first time Fed is doing such as experiment!

  • Term of the loan: The normal term of an emergency loan is for a few days to a few weeks. In this period, banks are expected to get their act together and return the funds to the central bank. However, loans under the Bank Term Funding Program (BFTP) will be made for a maximum tenure of one year. This increased tenure has been given to the bank since the external banking environment seems to be hostile and may take a year to stabilize.

    However, critics are wary about whether even one year will be enough. This is because most of these securities are long-term securities i.e. with a maturity greater than ten years. Hence, it is not that within one year, the security will get matured. It is quite likely that the Fed may have to provide an extension to such loans if the banking system does not stabilize in one year.

  • Recourse: Theoretically, the Bank Term Funding Program (BFTP) provides Fed with full recourse against loans made. This means that the Fed is not limited by the value of the collateral when they try to recover their loans.

    However, when we consider the practical situation, this recourse may not have much value. This is because if the bank is not able to pay Fed, it means that its assets are woefully less than its liabilities. As a result, the Fed may not have any assets left which they can cease and sell in the market to recover their dues. Hence, the Fed’s ability to recover the loans in the event of a bank failure is limited.

  • Signaling Effect: Commercial banks have traditionally been shy about taking funds from the discount window. This is because once news spreads about the fact that the bank has borrowed emergency funds from the central bank, their situation becomes worse. Depositors start pulling out even more money from their accounts and other banks are wary of dealing with this bank. This is because there is a signaling effect involved with borrowing money from the central bank.

    By borrowing money from programs such as Bank Term Funding Program (BFTP), the bank is making an implicit admission that they are in duress. Also, it is not possible to hide information regarding who is using facilities provided by the Fed. This is because the Bank Term Funding Program (BFTP) uses public money i.e. taxpayer funds. Hence, the Fed is obliged to maintain full transparency regarding the usage of these funds.

    It is possible that if a large number of banks start using the facility provided by Bank Term Funding Program (BFTP), the effect could be counterproductive. Instead of shoring up confidence in the banking system, it might destroy the confidence in the system and depositors might start moving funds out of the banking system as a whole.

  • FDIC: It is also important to note that the Bank Term Funding Program (BFTP) is an implicit guarantee by the Fed that all the money which is kept by the depositors will be protected. Hence, the insurance up to $250000 which is provided by the Federal Deposit Insurance Commission (FDIC) has become redundant. This might create a situation wherein depositors will continue to hold large deposits in one bank instead of spreading them across the system.

The fact of the matter is that the Bank Term Funding Program (BFTP) is highly controversial. There are many critics who claim that in the long term, this program will end up creating more problems than it solves.

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