The great deposit migration and emergency borrowing at the Fed discount window

REAL ECONOMY BLOG | March 17, 2023

Authored by RSM US LLP

The banking crisis has spurred a dramatic flight to safety at all levels of the financial system.

From investors seeking the assurance of money market funds, to depositors shifting their money from smaller banks to systemically important financial institutions, to banks themselves accessing greater liquidity from the Federal Reserve, the move has been nothing less than historic.

In the past week alone, the Federal Reserve’s loans outstanding to the financial system have ballooned to about $318 billion, up from $15 billion a week ago.

While it will be some time before we get an idea on the migration of deposits from small and midsize banks into systemically important financial institutions, retail investors and businesses haven’t been idle.

The Financial Times, citing data from the Investment Company Institute, reported that investors poured roughly $120 billion in cash into money market funds over the past week, with $93 billion moving on Tuesday and Wednesday.

The deposit carousel around the financial system has clearly begun.

Another sign of this profound shift is the dramatic surge in financial institutions’ use of the Federal Reserve’s primary credit lending program, known as the discount window. Between March 9 and Wednesday, there was $152.9 billion in demand for liquidity using the discount window, of which $148.3 billion represented an increase from one week ago, according to Fed data.

The prior high for weekly demand was $111 billion posted during the week of Oct. 29, 2008, at the height of the financial crisis.

The Federal Reserve’s Bank Term Funding Program (BTFP), announced on Sunday, received $11.9 billion in demand despite being far more favorable than the terms inside the primary lending facility.

In addition, the Fed has $142.8 billion in loans outstanding to two just-created Federal Deposit Insured Corporation bridge banks.

To put it all in perspective, the Federal Reserve, at the height of the financial crisis, had close to $750 billion in loans outstanding to the financial system. While this crisis is nowhere near the catastrophe of 2008, this recent stress represents a major disruption to the domestic financial system.

The takeaway

The economic implications are clear. The great migration of deposits from regional banks to larger banks and emergency borrowing facilities on the part of those banks will result in tighter credit standards, a reduction in lending, slower growth and higher unemployment.

That is a vivid example of tightening financial conditions, which will also, in the end, reduce inflation.

Such is the cost of a significant financial panic and banking crisis.