FRB Approves Final Rule on Procedures for Emergency Lending

The Board of Governors of the Federal Reserve System (“FRB”) approved a final rule specifying its procedures for emergency lending under Federal Reserve Act Section 13(3) (“Discounts for Individuals, Partnerships and Corporations”).

The FRB’s authority to engage in emergency lending has been limited to programs and facilities with “broad-based eligibility.” The final rule defines “broad-based” as a program or facility that is not designed for the purpose of aiding any number of failing firms and in which at least five entities would be eligible to participate. The final rule also broadens the definition of “insolvency” to cover borrowers who fail to pay undisputed debts that become due within 90 days before borrowing or who are determined by the Board or the lending Reserve Bank to be insolvent.

Like the proposal, the final rule incorporates the requirement in the Dodd-Frank Act that all lending programs under Section 13(3) be approved by the Secretary of the Treasury. The Board still must find that “unusual and exigent circumstances” exist as a precondition to authorizing emergency credit programs.

In extending emergency credit, the Board’s practice has been to set the relevant interest rate at a penalty rate designed to encourage borrowers to repay emergency credit as quickly as possible. The final rule was revised to improve the original proposal to incorporate this practice by requiring the interest rate for credit extended under section 13(3) to be set at a level that is a premium to the market rate in normal circumstances, affords liquidity in unusual and exigent circumstances, encourages repayment, and discourages the use of the program as circumstances are normalized.

Concerning these revisions, FRB Chair Janet L. Yellen said this: “The ability to engage in emergency lending through broad-based facilities to ensure liquidity in the financial system is a critical tool for responding to broad and unusual market stresses.”

The final rule will take effect on January 1, 2016.

Lofchie Comment: The question is whether depriving the FRB of the authority to make emergency loans to a beleaguered financial institution (unless others are in similar kinds of trouble) prevents it from saving the financial institution, and whether the failure of that financial institution then becomes the trigger for broader market failures. If one believes that the FRB acted appropriately in making emergency credit available to financial institutions during the financial crisis (which seems the proper role of a central bank in a liquidity crisis), then depriving the FRB of this power going forward seems illogical. Limiting the FRB’s power to act as a regulator without its being subject to the same constraints as other regulators seems much more logical than reducing the power of the FRB to provide liquidity in a time of market crisis.

Comments are closed.