American banks are taking advantage of an emergency funding program created by the Federal Reserve to generate profits, according to a recent article in the Wall Street Journal. The program, known as the bank term funding program (BTFP), was established after the 2023 Silicon Valley Bank crisis and allows banks to borrow money from the Fed at a lower rate than what the central bank pays them for their reserve deposits.
Since its inception just 10 months ago, U.S. banks have borrowed an astonishing $141 billion from the BTFP. The program offers loans of up to one year against collateral like U.S. Treasuries and mortgage-backed securities, charging banks an interest rate based on future expectations. The rate is calculated as the one-year overnight index swap rate plus an additional 0.1%.
While the Fed offers financing below 5% through this rescue program, it simultaneously pays banks 5.4% on parked reserve balances, resulting in a risk-free profit margin of about 0.4% for the banks. This practice has been described as a “free-lunch” situation by the Wall Street Journal.
The article quotes Janney Montgomery Scott analyst Christopher Marinac, who states that banks are taking advantage of this positive arbitrage to generate windfall profits. This arbitrage has had a significant impact on the U.S. financial sector, with shares in leading banks surpassing their pre-crisis values. The Financial Select Sector SPDR Fund (XLF) has experienced a surge of 20% since late October 2023, outperforming the SPDR S&P 500 ETF Trust (SPY) during the same timeframe.
Bank of America Corp. (BAC), Citigroup Inc. (C), Goldman Sachs Inc. (GS), and Wells Fargo Inc. (WFC) have all shown remarkable performance in the past three months, with gains ranging from 22% to 30%.
However, this lucrative situation for banks comes at a cost to U.S. taxpayers. The interest payments the Fed makes on bank reserves are a liability for the central bank. A report by the Federal Reserve Bank of St. Louis in November 2023 highlighted the imbalance between the Fed’s liabilities and assets. With rising policy rates, the Fed pays more interest on its liabilities, while its assets, often locked at fixed rates, don’t yield proportionate returns. This has led to the Fed’s operating costs surpassing its income since September 2022.
As a result, the Fed has created a “deferred asset” equal to the shortfall in earnings, amounting to $116.9 billion as of November 8, 2023. This means the U.S. Treasury will face a shortfall in cash transfers from the Federal Reserve until 2027, impacting the federal budget and ultimately falling on U.S. taxpayers.
The exploitation of the BTFP by American banks highlights the need for greater scrutiny and regulation to prevent such arbitrage practices and ensure a fair and balanced financial system.
