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January 13, 2014

'Discount Window Stigma'

Banks are reluctant to borrow from the discount window:
Discount Window Stigma, by Olivier Armantier: One of the main missions of central banks is to act as a lender of last resort to the banking system. In the United States, the Federal Reserve has relied on the discount window (DW) for nearly a century to fulfill this task. Historically, however, the DW has been little used even when banks may have faced acute liquidity shortages, a phenomenon commonly attributed to stigma. In this post, we show that during the last financial crisis banks were willing to pay large premia to avoid borrowing from the DW, suggesting that DW stigma is an economically important phenomenon.
DW stigma is generally defined as banks’ reluctance to approach the DW out of concerns that, if detected, depositors, creditors, or analysts could interpret DW borrowing as a sign of financial weakness. It is believed that such inferences could have severe consequences for DW borrowers such as a run on deposits, a loss of confidence by market analysts, a drop in the institution’s stock price, or a withdrawal of market sources of liquidity. The economic consequences of DW stigma may be particularly severe during financial crises, preventing the Fed from effectively disseminating liquidity when it is most needed. In addition, a bank that delays accessing the DW may resort instead to costly alternatives (such as fire sales of assets), which may further weaken the bank and add to financial system instability. Finally, a reluctance to borrow at the DW could lead banks to excessively self-insure against tail risks, thereby reducing the loans it extends to other financial firms and to the real economy. ...

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