WASHINGTON — The stigma attached to banks borrowing from the Federal Reserve Board's discount window has vanished in recent weeks — and may be gone for good, observers said.
As the financial crisis has deepened and cash flow evaporated, commercial banks have borrowed at record levels each week since Sept. 10, taking $107.5 billion on Wednesday.
It is a sharp turnaround from last year, when the central bank had to cajole the four largest domestic banks to borrow $500 million each in an attempt to show that taking money from the Fed was not a sign of weakness.
"Liquidity is at a premium, and that issue has clearly drowned out the stigma," said Adam Schneider, a principal at Deloitte Consulting LLP. Borrowing "is a good balance-sheet practice now as opposed to something that requires deep explanation."
How long the current perception will last — and the impact it will have — is the subject of much debate. Some argue that the stigma will never return.
"Once you've crossed that Rubicon, it's going to be hard to get back," said Marc Franson, a partner at Chapman and Cutler LLP.
Peter Peyser, a principal at Blank Rome Government Relations LLC, said, "I don't see us going back to the day when the discount window is a place that banks are going to avoid at all costs."
"They are cognizant of having that available," Mr. Franson said. "I think we've seen a fundamental shift."
Robin Lumsdaine, a former associate director in the Fed's banking supervision and regulation division who is now a professor at American University's Kogod School of Business, said use of the discount window should not "be viewed as necessarily negative, because there are legitimate and appropriate reasons to use it."
"That's why it's available," she said. "In the normal course of business, utilizing a variety of resources that are available to you is prudent business practice and good risk management."
Others argue that, if for no other reason than market discipline, it would be smart for banks to go back to avoiding Fed borrowing once the financial crisis has passed.
"Central banks are not supposed to be ordinary funding sources," said Gil Schwartz, a former Fed lawyer who now works in private practice. "Why would you waste resources and have people tied up making these loans when they should be able to go to the marketplace?"
If the discount window's stigma is a thing of the past, some wonder whether banks would come to view the Fed as a routine source of funding in much the same way they rely on Federal Home Loan bank advances for liquidity. That prospect raises concerns about whether the Fed can remain the economy's "lender of last resort" if it also becomes a staple of a bank's funding strategy.
"The Fed shouldn't be running every bank in the country," said Ed Grau, the head of Accenture's financial services risk management practice in North America. "The Fed should be managing overall money supply and liquidity and assess banks to see if they have adequate capital."
But Mr. Peyser said many public policy matters are being ignored as the Fed and other regulators focus on the problem of the day.
"A lot of public policy questions have been put aside in this crisis atmosphere," he said. "The public policy imperative became preventing a collapse of the financial system. The niceties of the central bank's role in corporate finance in the banking sector doesn't get discussed."
As discount window borrowing from commercial banks continues to set records, Mr. Grau said institutions should still take the loans with great caution.
"Make no mistake about it, you have to indicate how this is a benefit to the institutions and how this is a strategic source of funding as opposed to saying you need this for liquidity," he said. "If you just go randomly and walk up to the window without your story straight, there's going to be a lot of scrutiny on your assets."
The growing use of the discount window reflects its increased importance in the Fed's efforts to support the economy and get banks lending to each other again. The tool historically served as a source of overnight liquidity but the Fed began making term loans in August 2007. Now banks can take loans that take as long as 90 days to mature.
Since then the Fed has also narrowed the spread between the discount rate and the federal funds rate to 25 basis points, from 100, and made loans cheaper by cutting the discount rate to 1.75%, from 5.25%.
The newfound acceptance of the discount window took root in two stages, most observers said. The ground was initially softened in December when the Fed introduced cash auctions that became very popular. The central bank went on to offer similar sales of Treasury securities.
"That was a program to demonstrate that you can continually borrow from the Fed," Mr. Schwartz said. After the auction, "borrowing became less of a stigma."
The next stage began at the end of the summer when banks took a significant hit from the loss of value of preferred shares of Fannie Mae and Freddie Mac, which were seized by the government on Sept. 7. The situation became more stark last month in the aftermath of Lehman Brothers' collapse, when banks began hoarding money and the interbank lending market essentially froze.
"It became acceptable to borrow from the Fed when it became clear that people weren't lending to others," Mr. Schwartz said.
The structure of today's discount window is fundamentally different from before the crisis. The Fed's $85 billion loan to the insurer American International Group Inc. was made through the window along with support to investment banks and money market mutual funds.
Some of the programs, such as the auctions and the facilities for investment banks and money market mutual funds, are scheduled to end next year. But as the industry ponders the future of the discount window's relationship with commercial banks, some say higher prices may be the only way to pull institutions away from the loans.
"As the market thaws out and returns back to more self-sufficiency, you would widen that spread, because the government would want to play a lesser role of guaranteeing banks," Mr. Grau said.
