The Role of the Discount Window in Contingency

Funding Planning

Toby Trocchio - Manager, CRM

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Disclaimer

The views expressed herein are those of the author and not necessarily those of the Federal Reserve Bank of Cleveland or the Federal Reserve System.

This presentation is intended to provide those attending the seminar with information about

matters of current interest. It is accompanied by important supplemental remarks. It should not be

construed as advice concerning any specific supervisory, legal, accounting or other matter, and regulated institutions should not act upon it without

contacting the appropriate regulators or professionals.

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Today’s Agenda The Discount Window – an overview

The role of the discount window in contingency funding planning

Regulator perspectives on the discount window

The role of the Discount Window and your correspondent in account management

Getting started – documents, collateral options, etc

Maintaining, updating and testing your access

Common questions about the Discount Window

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The Discount Window – An Overview

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Discount Window Functions

Source of liquidity for individual institutions- Reliable back-up funding source to meet unexpected funding demands and needs

- Relieve liquidity strains in the banking system

Act as a safety valve in relieving pressures in reserve markets

Assure the basic stability of money markets

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Discount Window Credit Programs

Primary Credit

Secondary Credit

Seasonal Credit

Primary Credit Program Available to DIs in generally sound financial condition

- At least a “3” supervisory composite rating- At least adequately capitalized

Prior to August 2007 ,and subsequent to the spring of 2010 almost entirely overnight loans (can be up to a couple of weeks)

Rate is set as a spread over fed funds target rate (Discount) Rate

“No questions asked”

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Prudent Use of Primary Credit Program Short term back-up source of liquidity

- Unexpected operational issue: E.S FHLB borrowing had closed

- In danger of occurring a daylight overdraft

- Regional or institution contingency event (natural event, power outage etc…)

- Arbitrage

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Non-prudent use of the Discount Window Using the Discount Window as a primary source

of funding

Long term funding solution

Continued use of the window could be indicator of deteriorating financial condition

Inconsistent/ Unusual use of the window compared to past behavior

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Secondary Credit Program Available to DIs whose condition makes them

ineligible for Primary Credit

DIs generally composite 4 rated or worse and/or less than adequately capitalized- As the condition deteriorates so does the DW flexibility in lending

Rate is set as a spread over Primary Credit rate

Questions will be asked

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Secondary Program…… nuances Physical delivery of loan collateral may be required

at some level of deterioration- When in delivery documentation required may include:Original notes and associated mortgagesAny amendments and modificationsGuarantees and security agreementsUCCsOther documents as requested by the district

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Seasonal Credit Program Lends funds to institutions that can

demonstrate seasonality in lending and deposit activities

Maturity up to one month, can lend up to 9 out of 12 calendar months

Limited to institutions less than $500MM in total deposits that meet seasonality test

Example: DI’s specializing in agricultural and resort business

DIs must apply for the program

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Condition Monitoring CRM monitors the condition of all depository

institutions in the 4th District

When an institution’s condition deteriorates to an unhealthy level (generally, CAMELS 4 or 5), we normally take away daylight credit privileges and institute other risk control measures.

We will work with the primary regulator to understand the liquidity position of the institution and its future prospects.

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Regulator Perspectives on the Discount Window

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Regulator Perspectives on the Discount Window Occasional and prudent use of the Window for its

intended purposes should be considered unexceptional and acceptable

Discount Window credit can be a suitable and reliable back-up funding vehicle

Discount Window is a desirable element of liquidity and contingency funding plans

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The Role of the Discount Window in Contingency

Funding Planning

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The Role of the Discount Window in Contingency Funding Planning

• Contingency Situations• Institution-specific

• Local / Regional or

• Systemic

• Response expectations during contingency events• FRB Staff will strive to provide the highest level of assistance and information possible• Institutions are expected to manage their account through the contingency situation

• Business continuity plans are in place to direct an operational response for the event at hand

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The Role of the Discount Window in Contingency Funding Planning

CFP should incorporate the Discount Window, but in an appropriate manner

Scenario analyses should reflect the window terms as they would be available

Discount Window access should be complete and up to date if included in CFP

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The Role of the Discount Window and your

Correspondent in Account Management

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The Role of the Discount Window and your Correspondent in Account Management Federal Reserve membership is not necessary to

access the Discount Window

A Federal Reserve Master Account is not necessary to access the Discount Window

Correspondent agreements are common among participating institutions

Federal Reserve accounts are expected to be managed appropriately even if only used for purposes of Discount Window loans

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Getting Started – Documents, Collateral Options, etc.

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Getting Started – Documents, Collateral Options, etc. Loan agreements from Operating Circular 10

- Legal Documents Letter of Agreement Authorizing Resolutions for Borrowers Certificate Official Authorization List Correspondent Agreement (potentially)

Collateral- Securities- Loans

Program-specific requirements- Seasonal, TAF, other

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Getting Started – Documents, Collateral Options, etc. Securities

- Treasuries- Agencies- Municipals- Mortgage-backed and asset-backed- Many others

Loans- Borrower in Custody program allows DIs in sound condition to retain physical custody of loan files

- FRB takes custody of loan files pledged by DIs in weak condition – varies by district

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Getting Started – Documents, Collateral Options, etc. The DW provides valuation margins for the most

commonly pledged asset types. Assets accepted as collateral are assigned a lendable value (market or face value multiplied by the margin) deemed appropriate by the Federal Reserve Bank.

The financial condition of an institution may be considered when assigning values.- Additional haircut for troubled DIs

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Maintaining, Updating and Testing your Access

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Maintaining, Updating and Testing your Access Must do’s

- Establish- Maintain- Test - Manage

Incorporate Discount Window readiness management into your institution’s annual planning.

Involve your internal/external auditors to test plan management.

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Common Questions About the Discount Window

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- Why would a sound bank turn to the higher cost DW if other funding sources are available?

- Can a Primary Credit-eligible depository institution use the Federal Reserve as a regular source of funds?

- How do bank supervisors/examiners view an institution's borrowing from the primary credit program?

Common Questions About the Discount Window

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What costs are involved with establishing a DW arrangement?- Direct- Indirect

Timeline for setting up Discount Window capacity- Depends on:

Starting point Account status Collateral type Perfection issues

Common Questions About the Discount Window

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4th District Contact Information Discount Window Information

- www.frbdiscountwindow.org- www.clevelandfed.org/banking

Credit Risk Management Contacts- Toby Trocchio – Manager

ttrocchio@clev.frb.org 216-579-2955

- Todd Berardinelli – Banking Supervisor tberardinelli@clev.frb.org 216-579-2922

- Eric Polansky – Senior Credit Analyst epolansky@clev.frb.org 216-579-3036

- Garry Madis – Credit Analyst gmadis@clev.frb.org 216-774-2686

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Other questions…………

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Contact Toby Trocchio- ttrocchio@clev.frb.org- 216-579-2955

The Role of the Discount Window in Contingency

Funding Planning

Toby Trocchio - Manager, CRM

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