Late in the day yesterday, the Federal Reserve announced it had re-established the Primary Dealer Credit Facility (“PDCF2020”), a tool it previously used during the financial crisis to ease liquidity pressures. The facility allows primary dealers—broker-dealers that are trading counterparties of the New York Fed—to borrow directly from the Federal Reserve on a collateralized basis. Although the newly-announced PDCF will not significantly increase the number of financial institutions that may borrow from the Federal Reserve, it will likely free up capital at bank holding companies by facilitating such borrowing at the broker level. It will also increase available liquidity by accepting as collateral a broader range of assets, including equities, than the Federal Reserve accepts for loans made through the discount window.
PDCF2020 will be available Friday (March 20, 2020), and will offer overnight and term funding with maturities up to 90 days. The facility will be in place for at least six months and, according to the Federal Reserve’s press release, may be extended “as conditions warrant.” Other terms of the facility mirror the terms for borrowing through the Federal Reserve’s discount window (its overnight loan facility for depository institutions). Pledged collateral will be valued on a schedule similar to that used for the discount window, and the interest rate charged for borrowers using the PDCF will be the primary credit rate (or 0.25%), which is the same rate offered to depository institutions via the discount window.
Unlike the situation in 2008 when stand-alone investment banks did not have access to the Fed discount window, almost all eligible PDCF2020 borrowers already have access through bank affiliates to discount window liquidity as a result of consolidation and restructurings in the financial services industry during and after the financial crisis. In other words, the PDCF2020 does not significantly expand the number of non-bank broker-dealers eligible to borrow from the Federal Reserve in order to inject new liquidity into the market, as it did in 2008. However, we expect that for intra bank holding company financing purposes, PDCF2020 will be a welcome addition to the Federal Reserve arsenal being deployed in response to the current market turmoil. By allowing the broker-dealer subsidiary to pledge collateral and borrow funds through the PDCF, the bank holding company can avoid using the balance sheet of the bank subsidiary to provide liquidity to the broker-dealer through intercompany loans. Using bank assets in that way would limit capital and liquidity available to the bank subsidiary (which is subject to more stringent requirements set by the prudential regulators), and could affect banks’ ability to maintain required capital and liquidity levels. Intercompany loans in a time of crisis may also give rise to regulatory concerns at the banking holding company level (for example, the Federal Serve’s Regulation YY requires a bank holding company to conduct liquidity stress tests, including at material operating entities, and manage liquidity accordingly.)
Differences between PDCF2020 and the earlier 2008 facility indicate an intention for this facility to be used broadly. For example, when the PDCF was initially created in March 2008 in response to the impact of the Bear Stearns collapse, it accepted only investment-grade debt securities as collateral. The Federal Reserve broadened the scope of eligible collateral on September 14, 2008, in response to the impact of the Lehman Brothers bankruptcy. When deploying the PDCF2020, the Federal Reserve immediately indicated it would accept that later broad range of assets available for use as collateral, facilitating broader use.
It is difficult, however, to extrapolate further from the experience of the 2008 financial crisis when considering the PDCF2020. The current market crisis is markedly different than 2008, as the current market disruption was not triggered by a fundamental fear of the financial system faltering. In 2008, the Federal Reserve was criticized for providing support to failing financial institutions such as Bear Stearns, and for not providing support to failing institutions such as Lehman Brothers. In the wake of the financial crisis, the Dodd Frank Act limited the Federal Reserve’s emergency lending authority to providing broad-based lending capacity for the purpose of providing liquidity to the financial system; it prohibited the Federal Reserve from aiding a single failing financial company. That restriction is likely less relevant in the current market disruption. PDCF2020 is a program-based lending facility that is clearly allowable under the terms of Dodd Frank, and the financial institutions acting as counterparties to the Federal Reserve are not the entities in the most danger of failing.1 For many reasons, the PDCF2020 is a different construct from its predecessor and lessons learned in 2008 (including the restrictions imposed by Dodd Frank) may be of limited value as we try to understand how the PDCF2020 will impact the current markets.