(Bloomberg) — An alluring risk-free arbitrage opportunity is set to end after the Federal Reserve’s top bank watchdog signaled that the central bank is unlikely to renew a key lending facility created during last year’s banking crisis.
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The Bank Term Funding Program, which supported lenders through that tumult, “really was established as an emergency program,” said Michael Barr, the Fed’s vice chair for supervision, at an event Tuesday. The BTFP, which is slated to expire March 11, has attracted a swath of users in recent weeks as traders look to lock in loans at a rate that’s more attractive than the alternatives.
Barr’s remarks come just a day after Federal Reserve Governor Michelle Bowman noted in a speech that the facility is scheduled to end in a couple of months, sparking a flurry of chatter in markets that this could indicate the program wouldn’t be renewed. Usage of the BTFP has soared to an all-time high in recent weeks, prompting uncomfortable questions for the Fed on whether banks should be able to arbitrage their facilities in this manner.
“It shouldn’t come as a surprise to anyone but the announcement coming sooner than expected says to me that there is really limited tolerance from the Fed of banks taking advantage of any facility designed for emergency backstops,” said Deutsche Bank AG strategist Steven Zeng.
BTFP Boon
Usage of the program — which allows banks and credit unions to borrow funds for up to one year, pledging US Treasuries and agency debt as collateral — reached a fresh high of $141 billion in the week through Jan. 3, according to the latest Fed data.
That’s because the BTFP rate, calculated as the one-year overnight index swap rate plus 10 basis points, has come down as traders boosted bets on more rate cuts in 2024. Eligible institutions have found it cheaper to borrow cash through the nascent facility, paying about 4.93%, with the opportunity to park that cash in an account at the central bank that earns 5.40%.
The BTFP was invoked under the Fed’s emergency authority after the collapse of Silicon Valley Bank. That allowed for the establishment of a broad-based program under “unusual and exigent circumstances,” which requires Treasury approval. It was unanimously approved by the Fed board.
Yet since the lending program was introduced, concerns about bank deposit flight and unrealized losses on securities have eased. Fed officials are also trying to steer institutions toward other lending facilities, including the often-stigmatized discount window and the standing repo facility.
That doesn’t hurt the appeal of the BTFP while it exists. And banks will likely continue to take advantage of it until it expires as they seek to shore up reserve balances.
“Banks are choosing to further build their liquidity buffers in anticipation of the facility’s expiration,” said Mark Cabana, head of US interest rates strategy at Bank of America Corp. “If the Fed is going to be moving in the direction of cutting rates and banking-system risk has moderated, then do you need to have this facility renewed in an election year?”
–With assistance from Katanga Johnson.
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