NEW YORK: The growing gap between the rate on the US Federal Reserve’s (Fed) nascent funding facility and what the central bank pays institutions parking reserves suggests officials will let the programme expire in March, according to Wrightson ICAP.

       The Fed introduced the Bank Term Funding Programme (BTFP) earlier this year as the banking crisis roiled markets.

       The programme allows banks and credit unions to borrow funds for up to one year, pledging US treasuries and agency debt as collateral valued at par.

       The rate for these loans, one-year overnight index swaps (OIS) plus 10 basis points, is currently 4.84% and 56 basis points lower than the rate for interest on reserve balances.

       Since the Fed’s pivot earlier this month to forecasting more interest rate cuts next year, OIS rates tracking them have tumbled, taking BTFP’s with them and boosting the attractiveness of the arbitrage trade.

       The lower costs drove borrowings to a record high US$131bil in the week through Dec 20, according to the latest Fed data.

       Rising usage, coupled with the arbitrage opportunity have led market participants to question whether the central bank will close this window for new loans that is set to expire on March 11, 2024, as bank funding conditions have retreated from extreme levels and its role as an emergency liquidity backstop has diminished.

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       “In justifying the generous terms of the original programme, the Fed cited the ‘unusual and exigent’ market conditions facing the banking industry following last spring’s deposit runs,” Wrightson ICAP economist Lou Crandall wrote in a note to clients.

       “It would be difficult to defend a renewal in today’s more normal environment.”

       Fed officials have yet to comment on whether the BTFP will be extended.

       Even if policymakers opted to close the programme, the Fed has other tools banks can use in the event they need last-minute liquidity: the discount window and the standing repo facility (SRF).

       Officials have been trying to remove the long-standing stigma associated with the window.

       The SRF, a tool made permanent in July 2021, allows eligible counterparties, the primary dealers and about 25 banks at the moment, to lend eligible securities and borrow US dollars at an administered rate, about 5.5%.

       Fed governor Michael Barr said in a speech earlier this month banks should be prepared to borrow from the Fed’s discount window as part of a range of liquidity resources, underscoring that institutions should be prepared to use the facility in good times and in bad.

       “The stakes in the stigma debate are particularly high right now,” Crandall wrote. “The Fed hopes that the new standing repo facility will serve as a frictionless ceiling tool in the coming years.

       “That will happen only if banks view SRF borrowing purely as a commercial decision and not as a reputational or regulatory risk.” — Bloomberg