Most consumers are familiar with the work of the Federal Deposit Insurance Corporation (FDIC) when a bank fails; but did you know that there is a bank installment loan program that could have prevented the collapse of SVB and any other bank?
“Better safe than sorry,” goes a Mexican proverb that applies to any issue, including the U.S. banking system. While the Federal Deposit Insurance Corporation (FDIC) guarantees that your money is protected up to a certain amount if a bank fails, as what happened with Silicon Valley Bank, there is also the Federal Reserve’s (Fed) bank installment loan program that could have prevented SVB’s collapse.
After what happened with SVB, analysts have recalled the existence of this program, assuring that it is an essential tool to avoid the failure of any other bank.
What is the Bank Installment Loan Program?
The Bank Term Loan Program (BTLP) is “an additional source of liquidity against high-quality securities, eliminating an institution’s need to sell securities quickly in times of stress,” says the Fed.
In other words, BTLP seeks to give banks access to cash to liquidate their customers’ financial needs and avoid bankruptcy.
BTLP is partly the brainchild of Douglas Diamond and Philip Dybvig, who won the Nobel Prize last year (along with former Fed Chairman Ben Bernanke) for their work on bank runs and how to prevent them. They found that if customers know that their bank deposits are insured, a bank run is very unlikely to occur.
The BTLP is made up of three parts essential to the financial support of the banking system:
It grants loans to banks.
Financial institutions will be able to borrow cash from the Federal Reserve Bank for up to one year using bonds, mortgage-backed securities and other types of debt as collateral. That means if a bank needs to shore up cash quickly to meet the pace of customer withdrawals, it could do so.
Value the bank’s Treasury bonds and other securities at “par.”
The Fed’s rate hikes have undermined the value of the Treasury bonds that banks depend on as a key source of capital. U.S. banks currently hold about $620 billion in unrealized losses on bonds, according to the FDIC. If any of them need to access a large amount of cash quickly, they would have to sell it at a loss, perhaps a substantial loss, as SVB did last week.
BTLP aims to solve this problem by valuing bonds used as loan collateral at “par.” If a bank brings in a bond they bought for $1,000 that is now only worth $600, they will still get $1,000 cash.
Guarantees the U.S. banking system.
The program seeks to instill confidence in the U.S. banking system, as its loans will be backed by $25 billion from the U.S. Treasury. Simply put, if the bank cannot repay its loan, the government will.
When banks sell large amounts of “super-safe” assets like Treasury bonds at a loss, it indicates that they exhausted all other options to raise capital to pay customers, and failed. The Fed’s program eliminates that scenario and provides assurances to bank customers that their money is safe and backed by the U.S. Treasury.