Recent regulatory discussions typically highlight three key areas of focus: cybersecurity and fraud, challenges in the commercial real estate sector — particularly office vacancy rates — and contingency funding and liquidity sources. In this article, we’ll focus on the third topic: contingency liquidity planning.

Contingency Funding Via the Discount Window

In the aftermath of the 2023 bank collapses, other financial institutions faced a sudden run on deposits from rattled customers. The cash crunch arrived swiftly, and many financial institutions discovered that they hadn’t planned for the operational process or anticipated any challenges that could arise when applying for emergency funds.

As the door suddenly closed on bank deposits, the Federal Reserve Discount Window remained open for those who needed emergency loans. Although Discount Window borrowing the month after SVB and Signature Bank failed reached a record $153 billion, not all financial institutions jumped at the opportunity presented by Discount Window.

Nearly all financial institutions with more than $50 billion in assets borrowed from the Discount Window at least one time from 2010 to 2021; only 40% of institutions between $250 million and $1 billion did the same. Financial institutions under $250 million in assets? Less than 20%. Why is the Fed Discount Window underutilized by community banks, and what can be done to help them access it, especially in the face of continued economic uncertainty and changing consumer behavior?

Fed Discount Window Guidance

Community banks should include the Discount Window in their contingency plans for financial emergencies and may want to test and maintain their operating procedures for using the Discount Window.

The first step in working with the Discount Window is understanding exactly what it is. In the beginning, it was an actual teller window at Federal Reserve lobbies where bank employees could come to take out loans. It’s a virtual window these days, with financial institutions applying with the Fed for short-term loans (usually just overnight) that provide quick infusions of cash to help with liquidity crunches.

According to the Fed’s guidance, operational readiness for Discount Window borrowing includes several parts:

1. Establish borrowing arrangements. Be familiar with the Fed branch of your district and how to access its Discount Window. This includes developing a backup plan of other sources to borrow from besides the Fed Discount Window, as sometimes these lines become inaccessible during a crisis.
2. Understand collateral requirements. Emergency funding through the Discount Window requires collateral, so make sure sufficient collateral is available and that you know the pledging process for multiple types of collateral.
3. Pre-pledge collateral. Pre-pledging collateral can help speed up the process, especially if the need for liquidity is sudden.
4. Get familiar with the process. Be familiar with the Discount Window website and the requirements for community banks based on size. Community banks with over $250 million in assets, for instance, must prove borrowing access and maintain a membership to the Central Liquidity Facility, whereas a bank under $50 million in assets need only create a written policy outlining how they will manage liquidity and what contingent liquidity sources they can tap into if the need arises.
5. Test your readiness. Periodically test readiness by making small Discount Window transactions. This will ensure that your employees maintain familiarity with how the whole process works.

The Fed Discount Window is an invaluable source for dealing with fast-moving cash crunches, but institutions need to be prepared to borrow by having solid Discount Window procedures as part of their financial emergency contingency plans. One key lesson from the banking challenges of March 2023 is clear: A bank can never have too many sources of contingency liquidity — whether from the FHLB, the Federal Reserve, your correspondent bank or other reliable funding partners. Being versed in these contingency funding options can increase your community bank’s readiness in an emergency situation and lower the chances of any difficulties or hiccups in the process.