By enhancing the availability
of discount window credit, the new primary credit program offers depository
institutions an additional tool for managing short-term liquidity
risks. Management should assess fully the potential role that primary
credit might play in managing their institution’s liquidity and consider
the appropriateness of incorporating it in their liquidity-management
policies, procedures, and contingency plans. In light of the new primary
and secondary credit programs, institutions should update existing
policies, procedures, and contingency plans and remove any reference
to the Federal Reserve’s former adjustment and extended credit facilities.
The new primary credit program has the following attributes
that make the discount window a viable source of backup or contingency
funding for short-term purposes:
- A less-burdensome administrative process than applied
under the previous adjustment credit program makes primary credit
a simpler and more accessible source of backup, short-term funding.
- Primary credit can enhance diversification in short-term
funding contingency plans.
- Discount window borrowings can be secured with an
array of collateral, including consumer and commercial loans.
- Requests for primary credit advances can be made anytime
during the day.4
- There are no restrictions on the use of short-term
primary credit.
If an institution incorporates primary credit into its
contingency plans, the institution should ensure that it has in place
with the appropriate Reserve Bank the necessary collateral arrangements
and documentation. This is particularly important when the intended
collateral consists of loans or other assets that may involve significant
processing or lead time for pledging to the Reserve Bank.
It is a long-established sound practice
for institutions to periodically test all sources of contingency funding.
Accordingly, if an institution incorporates primary credit in its
contingency plans, management should occasionally test the institution’s
ability to borrow at the discount window. The goal of such testing
is to ensure that there are no unexpected impediments or complications
in the case that such contingency lines need to be utilized.
Institutions should ensure that
any planned utilization of primary credit is consistent with the stated
purposes and objectives of the program. Under the primary credit program,
the Federal Reserve generally expects to extend funds on a very short-term
basis, usually overnight. Therefore, as with any other type of short-term
contingency funding, institutions should ensure that any use of primary
credit facilities for short-term liquidity contingencies is accompanied
by viable take-out or exit strategies to replace this funding expeditiously
with other sources of funding. Institutions should factor into their
contingency plans an analysis of their eligibility for primary credit
under various scenarios, recognizing that if their financial condition
were to deteriorate, primary credit may not be available. Under those
scenarios, secondary credit may be available.
Another critical element of liquidity management
is an appropriate assessment of the costs and benefits of various
sources of potential liquidity. This assessment is particularly important
in managing short-term and day-to-day sources and uses of funds. Given
the above-market rates charged on primary credit, institutions should
ensure that they adequately assess the higher costs of this form of
credit relative to other available sources. Extended use of any type
of relatively expensive source of funds can give rise to significant
earnings implications, which, in turn, may lead to supervisory concerns.
It is also important to note that the Federal Reserve’s
primary credit facility is only one of many tools institutions may
utilize in managing their liquidity-risk profiles. An institution’s
management should ensure that the institution maintains adequate access
to a diversified array of funding sources. That array has traditionally
included, and should continue to include, liquid assets such as high-
grade investment securities and a diversified mix of wholesale and
retail borrowings.