Borrowing from the Federal Reserve’s Bank Term Funding Program (BTFP), an emergency lending initiative, surged to a record high of $167.8 billion, marking a significant increase of $6.3 billion in the week leading up to January 24. The BTFP had experienced growing demand, primarily fueled by its interest rate falling below the rate institutions could earn by parking reserves at the Federal Reserve, creating an arbitrage opportunity.
The surge in borrowing from the BTFP comes as financial institutions took advantage of the program’s attractive terms. However, the Federal Reserve responded to this trend by raising the facility’s interest rate, aiming to prevent institutions from capitalizing on the favorable conditions. The interest rate adjustment was implemented to ensure that the BTFP borrowing rate would be no lower than that for reserve balances.
The BTFP, initiated during the banking crisis last year, allows banks and credit unions to borrow funds for up to one year, with US Treasuries and agency debt serving as collateral. The borrowing rate is tied to market swap rates, which have decreased in recent months as traders anticipated potential monetary easing from the Federal Reserve.
The recent adjustment in the BTFP’s interest rate effectively eliminated the risk-free arbitrage trade that institutions had been leveraging. Before the change, the BTFP borrowing rate was around 4.88%, approximately 52 basis points lower than the interest paid on reserve balances.
Ian Lyngen, Head of US Rates Strategy at BMO Capital Markets, noted that the Federal Reserve’s decision to address the mismatch in rates was appropriate from a monetary policy perspective. The Federal Reserve has confirmed that the BTFP will close as scheduled on March 11, aligning with previous signals from top central bank officials to wind down the program and discontinue new loans.
Comparatively, the usage of the BTFP has surpassed that of the Fed’s discount window, where borrowing stood at $2.8 billion in the week ended January 24. This amount is considerably lower than the all-time peak of $153 billion reached last March during the onset of the banking crisis.
