MNI EXCLUSIVE: Stigma A Concern For Fed Standing Repo Facility

By Jean Yung and Evan Ryser

     WASHINGTON(MNI) - Stigma fears associated with borrowing directly from the

Federal Reserve may significantly limit the usage of a standing repo facility,

current and former Fed officials told MNI, complicating the debate over the

proposed tool to ease strains in money markets.

     The Fed would need to encourage regular usage of the repo facility by

pricing it competitively and making it available to a broad set of

counterparties, sources said. Even then, officials aren't confident the new

facility would be free of the stigma that has prevented banks from tapping the

Fed's discount window in times of stress.

     "Institutions now like to say our liquidity sources don't involve any

borrowing from the Fed," Bill Nelson, former deputy director of monetary affairs

at the Fed Board, told MNI. "Would people feel more comfortable using a standing

repo facility? I'm not sure that they would."

     Fed officials will soon debate the merits of the tool, which would readily

convert Treasuries or other acceptable collateral into cash. Proponents of the

facility say it would act as a safety valve for money markets by capping

short-term rates during a liquidity crunch. Economic modeling also predicts that

it would reduce banks' day-to-day demand for reserves, allowing the Fed to

shrink its balance sheet by a large margin, they argue.

     But the extent of banks' willingness to use any Fed credit facility is

little known and remains a big caveat to these predictions.

     --PRICING AND COUNTERPARTIES

     Fed research suggests that pricing the standing repo facility at market

rates and making it available to a broad group of reserves-holding entities

might encourage its use, sources said.

     The rate would have to be low enough so that its usage by big banks would

not be looked upon as an indication of stress but not so low that it gets used

on a daily basis by several hundred smaller institutions, displacing private

lending and potentially leading to large swings in the size of the Fed's balance

sheet. As a reference, the interest penalty on discount window borrowing

compared to the top of the fed funds rate target range is 50 bps.

     Who gets access also matters. Asking a small number of primary dealers to

pass on funding from the Fed to other users comes at a cost to dealer balance

sheets and may be problematic. Only dealers can access cash from the Fed via its

temporary repo operations put in place to avoid a repeat of September's

unexpected spike in short-term borrowing costs.

     Opening up a standing repo facility to all banks, thrifts and credit unions

would offer a direct incentive to hold less reserves and thus help keep the fed

funds rate within the FOMC's target range. But it would also increase the Fed's

role in repo markets.

     --EXISTING TOOLS

     Another way to overcome the stigma factor is by requiring banks to figure

direct borrowing from the Fed in their contingency planning, whether that

vehicle is the standing repo facility or the discount window.

     Fed Vice Chair Randy Quarles last week appealed to top bankers at the Money

Marketeers forum to let the discount window play a role in their stress

planning.

     "With this approach, we would not need to set up any new programs," Quarles

said. While the standing repo facility is "still of interest," he said, "there

may be benefits to working first with the tools we already have at our immediate

disposal."

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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