Fed's New Tool: BTFP...is it Inflationary?
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What is BTFP?
Will banks use BTFP?
Is BTFP a sneaky form of QE?
Because of BTFP, should you BTFD?
By now many of you have heard that the Fed and Treasury stepped in to rescue SVB and its depositors, and they instituted a new program called BTFP. There’s a ton of confusion about the program and whether it’s mildly inflationary, a new form of QE, or even outright money printing, as Bloodgood suggests here.
But what exactly is BTFP, and is it any or all of these?
The short answer is yes, no, maybe, and yes.
It’s super important for the overall state of banks today, though, and therefore the state of the financial system. The global financial system, that is. But no worry, we’re going to unpack all this nice and easy, as always, for you today.
So, grab that cup of coffee, saddle up, and settle in. It’s Informationist time.
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🧐 What is BTFP?
First things first, what the heck is BTFP and how does it work?
A brainchild of the Treasury and the Fed last week, BTFP stands for Bank Term Funding Program, and its purpose is to allow the Fed to provide liquidity to banks who could find themselves underfunded due to large and sudden customer deposit withdrawals.
I say ‘underfunded’, but let’s face it, these banks are demonstrating a monumental level of ignorance or arrogance, maybe both. And if you are wondering what I mean by that, or want to refresh on the whole SVB meltdown, I wrote all about that a couple weeks ago, and you can find that here:
TL;DR: The banks lent out too much of their deposits, took on interest rate risk in US Treasuries, did not hedge that risk, and found themselves standing buck-naked when the tide went out.
In essence, SVB and its depositors were explicitly bailed out, and BTFP is likely helping other small banks suffer the same fate.
To understand how BTFP does this, here are some its key aspects:
When in need of capital, eligible banks (any US FDIC and some foreign banks) can borrow against their securities instead of selling them in the open market,
Eligible securities are U.S. Treasuries and high quality mortgage-backed securities
There is no haircut, banks can borrow up to 100% of the collateral
That collateral is valued at par, not market value
The rate is the 1 year overnight swap rate (OIS) plus 10 (measly) bps
No pre-payment penalty
Loan term is for 1 year
No transaction fees
Treasury is backstopping the Fed banks for program
Program is in effect until at least March 11, 2024
In other words, there are no fees, no penalties, banks can pledge Treasuries and borrow against 100% of their face value at a cost of the 1yr swap rate + 10bps.
In finance, we would call this a sweetheart deal. So attractive as to be unethical or illegal.
To understand why this is a sweetheart offer, we need to look at the other available sources of liquidity for the banks, namely the Fed Discount Window.
I wrote all about that here, if you want a deeper dive on Repos, Overnight, and the Discount Window:
But for today’s purposes, here are the main differences.
First, the Discount Window carries a large stigma with it. It is basically the liquidity of last resort for any respectable bank.
Because if a bank has to borrow from the Fed itself, that means it has been rejected by virtually all other banks and has nowhere else to turn.
When you borrow from the Fed in the Discount Window, you are borrowing at a higher interest rate, you have to pay fees (sometimes hefty), you get large haircuts, meaning your collateral is only good for so much, and your securities are marked to market (and so the Fed requires a whole lot more collateral to lend against than other banks normally would).
Borrow from the Discount Window and you are pretty much admitting you are a sub-prime borrower, a high risk, with a significant potential to default.
So, won’t banks be labeled similarly if they use the BTFP line?
Aren’t they admitting liquidity problems? Deposit deficiencies and balance sheet weakness?
You would think so, wouldn’t you?