Demand for Fed funding tool hits record before rate hike

Borrowing from a Federal Reserve emergency lending program rose to a fresh record, just before the central bank raised the facility’s interest rate to stop financial institutions from taking advantage and arbitraging on its attractive terms.

Demand for the Bank Term Funding Program rose approximately $6.3 billion in the week through Wednesday, Jan. 24 to an all-time high of $167.8 billion, data from the Fed showed. Borrowing has jumped by more than $50 billion since mid-November after the program’s rate increasingly fell below the rate at which institutions could earn money by parking reserves at the Fed.

But that risk-free arbitrage trade effectively ended after the Fed announced late Wednesday that the cost to borrow via the tool will increase, effective immediately, to “be no lower” than that for reserve balances. Before the change, the BTFP borrowing rate was around 4.88% – some 52 basis points lower than the interest paid on reserve balances.

“The Fed was right in the change it made,” said Ian Lyngen, head of US rates strategy at BMO Capital Markets. “There was no sense for that mismatch to persist from a monetary policy perspective.”

Facility Shutdown

Launched during the banking crisis last year, the BTFP 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 this borrowing was tied to market swap rates, which have gone down in recent months as traders raised expectations of monetary easing from the Fed.

As part of the announcement Wednesday, the Fed also confirmed the BTFP will close as scheduled on March 11. Top central bank officials had increasingly signaled plans to shutter the program and cease making new loans. Use of the BTFP dwarfs that for the Fed’s discount window, where borrowing was only $2.8 billion in the week ended Jan. 24, far below an all-time peak of $153 billion reached last March, when the banking crisis erupted.

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