The safety net for banks

0:00Support comes from our 2025 lead sponsor of Planet Money, Amazon Ads. Less than half of customers fully trust their financial institutions. Amazon Ads helps financial brands build that trust through relevant ads, using first-party signals to reach the right customers. More at advertising.amazon.com. This is Planet Money from NPR. Betsy Duke worked in banking for 30 years. She ended up on the board of governors of the Federal Reserve System, and she was the chief financial officer of a little community bank in the blazer with giant shoulder pads era. Did you have like poofy bangs? I did. No, I don't think so.

0:45No, I did not. Okay, dodge that one. Are we wearing a power suit? Oh, I'm sure, yes. Okay, how wide are your lapels? Oh, I don't really know because you remember this span from the mid-70s all the way through to... Okay, so we're talking like inches of difference in lapel width. Yeah. Okay. We're talking about power suits because Betsy was in the business of running a community bank in Virginia Beach. It's called the Bank of Virginia Beach. We were a very small bank. I don't know, maybe$50 million or something. And that's a million with an M. For context, Goldman Sachs is like$1.44 trillion with a T.

1:23I was calling Betsy to ask her about her most stressful day at that job in Virginia Beach. She remembered it very clearly. It started when the bank sued a customer, and they said in their lawsuit that this customer owed them$2 million. The next morning, the headline in the paper, local paper, is local bank loses$2 million. And, you know, I'm just like really freaked out. This, for a banker, is a nightmare. A person reading that local paper might be like, oh, shoot, I have my money at that local bank, and that local bank just lost a bunch of money? Hopefully not my money. I'm going to go get it out just to be sure.

2:00And if one local customer comes to demand their money, that's fine. The bank is able to give them their money. But if everyone reads the paper and gets freaked out and comes to demand their money, that is not fine. Because banks don't keep every customer's money in their vault. They lend it out so they can earn interest and make money on the money. That's banking. So if a lot of customers demand their money at once, that's a bank run. It's panic all of a sudden just overwhelming the ability to access cash on very short notice. It can ruin a bank real fast. And that is lurking in the back of Betsy's mind.

2:39So Betsy goes into the office, sits at her desk. She takes this deep breath. She looks out the window and she sees her mom. In the middle of all this, my mother came in. And I said, what are you doing here? And she said, well, I'm here to get my money. Oh my God, Mom. And I said, are you kidding me? What? It turned out this had nothing to do with the lawsuit or the$2 million. Her mom wanted to take her money out so that she could take advantage of a promotion at another local bank. Apparently they were giving TVs out if you deposited money there. And I said, Mama, go home. I'll buy you a TV, but leave your money here.

3:18I just had patience of the news showing up and there's my mother withdrawing her money. So after Betsy has put out the mom fire, she turns her attention back to the main fire. She has a game plan in case of a bank run. She says every bank should have one. You need playbooks on how, where, what, who. If something happens and we start seeing our deposits go out, these are all the actions we need to take so that everybody knows what to do. And one crucial thing that Betsy does is make a call to the Central Bank of the United States, the Federal Reserve. The Fed has a lot of tools that they can use to help banks in trouble.

3:58One of the oldest tools is for exactly this kind of situation, to help banks avoid death by bank run. That tool is called the discount window. The discount window is essentially a way for a bank like Betsy's to get a loan from the Fed so that they have money for any panicked depositors knocking down their door. They can get that money now and pay the Fed back later. Was that a moment when you did access the discount window? Oh, I had alerted the Fed, and I'd alerted all our regulators what was going on, and I told them I might need it. And they were, to their credit, they were very much, let us know what you need, we're here.

4:36And we were in communication very strongly at that point. Betsy's depositors don't end up freaking out that day. Everything turned out fine. But that thing she didn't end up having to do, the lever she left untouched, recently, a lot of banks did pull that lever. In the first half of March, three banks had relatively classic bank runs and went under, which sparked some major banking stress. And the Fed got a lot of requests like, hey, your window, can I use it? Can I get a loan? So we got curious about this window because it seemed to be pretty important during this very stressful banking moment.

5:18Hello and welcome to Planet Money. I'm Jeff Guo. And I'm Mary Childs. Today on the show, the discount window is one of the central bank's most important tools to help keep banks alive and healthy. It's basically a safety net for the banks. And it seems like suddenly a lot of them needed it. So what is this window? Where did it come from? How does it work? And in all this recent banking turmoil, was it working the way it should?

5:52Support comes from our 2025 lead sponsor of Planet Money, Amazon Ads. What do financial customers want more than low fees, promo offers, or premium perks? Trust. It's the number one factor that drives loyalty. Amazon Ads helps financial brands build that trust through relevant ads that reach customers at key decision moments, whether they're planning retirement, buying a home, or managing debt. Using rich first-party insights, Amazon Ads connects brands with the right audiences where they browse, buy, and stream. Learn more at advertising.amazon.com. This message comes from Cachava. Indulge in holiday cravings with the nutrition you need from Cachava's all-in-one whole body shake.

6:38It packs 25 grams of protein, 6 grams of fiber, greens, and more. High quality ingredients with no fillers or nonsense. Try the newest flavor, limited edition chocolate mint. Go to cachava.com and use code NPR for 15 % off. That's cachava, K-A-C-H-A-V-A dot com, code NPR. The story of the discount window starts with the birth of the Federal Reserve, which goes back to 1907 and this cascade of financial calamities. The U.S. is in a recession. The stock market crashes. A bunch of banks fail. Everyone panics and runs to their local banks to demand their money. And the banks, as you know, don't have the money.

7:25So they end up turning to one of America's richest guys, J. Pierpont Morgan, who organizes a bailout. The panic ends, after which he's like, guys, this cannot be the plan. We have got to do better. What if I had been on vacation in Europe when you needed money and your telegram didn't reach me on my boat? What if I die? So in 1913, we started with the Federal Reserve System, as we know it. This is Amir Tosh Prananandam, a finance professor at the University of Michigan's business school. He's tosh to his friends. And he says when the Fed was set up, the point was for it to be the lender of last resort, a backstop to the banking system to make everyone feel better, that a good bank having a bad day could always get a loan easily and quickly.

8:13And the main way the Fed made these loans was through the discount window. So it's been around with us as long as the Fed has been around with us. Now, banks do have other ways to get money when they need it, like from each other. If you're a bank with extra cash, you can lend it to another bank and make a little money by charging your fellow bank an interest rate on that loan. But the Fed wants their discount window to be super easy to use. They don't want a bank that's in any kind of trouble, even a little bit of trouble, to have a hard time getting the help that they need. So the Fed builds the discount window as a cheaper alternative.

8:51the interest rate on their loan is less than the rate that you could get from other banks. I'm talking about 1920s and early days. So rates were lower than the market rate. So in early days, banks will use this a lot because it was attractive. And at first, way before power suits and poofy banks, the discount window was a physical window. It was a real place. You are talking about the early days of this system where a bank will literally go to a teller at the Federal Reserve Bank and give them some collateral and get the approval for funds. Like physically? Yeah. I walk up to my local Fed? Yeah.

9:34Like when, let's say, you and I, we go to our local bank. We go to the bank teller and we say that, hey, we want to withdraw some money. And here is a collateral. So keep my watch. Give me money. I will just note for the record that no bank has ever asked me for my watch. I don't know if my loans aren't big enough or my watches aren't nice enough. Collateral makes a loan super safe. The reason the bank takes Tosh's watch is because if Tosh skips town or doesn't pay for whatever reason, they can sell his watch and get their money. In the case of a bank, the banker is handing over like banky collateral, like bonds.

10:09Maybe they're U.S. government bonds or bonds from other governments or like corporate bonds. You just bring that valuable collateral to the window and you walk away with some money in the form of a loan. So that's the window part. And the discount part is that you give a collateral that is valued at$100 and they'll discount it a little bit and give you a lower amount. So if your bond is for$100, the Fed will inspect your bond, look at how much it might go for in the market, like maybe it's trading at$98. And the Fed will say, for money today, best I can do is$95. That's the discount part. They give you less money than the collateral is actually worth.

10:48Yeah. The window where they take a discount off what you have. Absolutely. Then the bank comes back later, often the next morning, pays the Fed their$95 back, plus that little bit of interest, and the Fed gives back the bond, the collateral. So that's how the discount window works. It started out as this way for banks to get a quick and easy loan when they need it, whether that's because they're having a bank run or for a more chill reason. Like, maybe they're really small and some big client takes out all their money and that leaves the bank with a temporary but disproportionately large hole.

11:20Or maybe they're a bank in a beach town like Betsy, so there's less money on hand in the winter. Whatever. Stuff like that. And just we should say that the discount window is one of the Fed's many tools. And today we are only talking about the discount window and we're ignoring all the other tools. So when it first opens, banks love the discount window. They use it all the time, which like, yes, the Fed wants banks to use the window, but not all the time. The Fed is supposed to be the lender of last resort, not first resort. Yeah, they were supposed to be a safety net for banks. But if you're relying on the safety net as part of your business model, maybe you're taking too many risks with your depositors' money.

12:02So over time, the Fed wanted to discourage that behavior because the Fed never wanted this to be something that banks could use all the time. Also, if you are just leaning on the Fed all the time, are you even a real business? Or are you sort of part of the government? Why are we bothering pretending this is a private enterprise? So the Fed wanted to kind of push the little bank birdies out the window. They need to make the discount window less attractive to gently discourage banks from using it. Unless necessary, of course, and then they should absolutely feel free to use it. Exactly. That is a really hard balance.

12:42And over the decades from the 30s through the 80s, the Fed tries a few approaches. Number one, they try straight up pressure. They tell the banks, hey, you're really not supposed to use this all the time, OK? This is for people who really need it. But they keep charging those lower rates. So banks are kind of like, yeah, OK, sure, whatever. I really need it. Thank you. Number two, the Fed starts adding these rules. So if you want to use the discount window, you're going to have to jump through some hoops. Like you have to say what you're going to use the money for. And certain activities are not appropriate.

13:18And one rule that they added in 1973 is especially effective. They required banks to have exhausted all their other options from the markets before coming to discount window. Now, banks have to ask to see if anyone else will lend them the money. And only if everyone else says no, then can they go to the discount window. Which introduces this important new element, a social element. Then the market will say that, wait, if I come to know that a bank has borrowed from the discount window, it must be a signal that the bank is in trouble, that it failed to borrow from any other sources. And that's why it went to the Fed.

14:03Right. So then came a point where nobody wanted to use it. This is what's known as discount window stigma. People have started to feel like if you're borrowing from the discount window, you might be in trouble. And there are two troubles a bank can be in. There's a liquidity trouble, which is kind of just a today-ish problem. The bank will be fine after whatever panic subsides or things restabilize. They just need some cash. And the other kind of bank trouble is the really bad one. Insolvency. An insolvent bank has run out of money and then some. They almost certainly are going to collapse. And the Fed is only supposed to lend to solvent banks, the ones with those temporary liquidity problems.

14:49By the time a bank is insolvent, it's too late. So in theory, it's very nice and easy to say an illiquid bank and an insolvent bank. In practice, it's very hard to tell them apart. Who is illiquid and who is insolvent often gets very, very difficult to tease out. In bad times especially? Especially in bad times, exactly. Which contributes to the sense that if a bank accesses the discount window, maybe they are in the bad trouble. So at this point, bankers start to feel very different about the discount window. It's not the free money times of the 1920s. Banks still use it, but they don't like to talk about it.

15:33There is always this fear that a banker has that somehow people will know. If I'm at a cocktail party with bankers, it's not going to happen that they're going to be like, Oh, my God. I went to the discount window last week. It was crazy. No, no, no, no. Not at all. I mean, they have to really, really hide it. The Fed's whole goal here was to discourage banks from using the discount window when they don't need it. And the stigma certainly helps with that. But it's a tricky balance. The Fed doesn't want the stigma to go too far. They want banks to use the window if they need it. They don't want banks to be too ashamed to ask for help.

16:10So they make one more big change to the discount window. This whole time, the window had offered cheap money, cheaper money than banks can get anywhere else, which was kind of the point. They wanted this to be super easy, right? But by 2003, the feds decided to try something new. They raised the price of money at the discount window. Now the discount window will be more expensive than the regular market. So at that time, in 2003, there was a shift in Fed's mindset. And the thinking was that, listen, against good collateral, we will lend freely at a rate that is a penalty rate. That is a rate that is slightly higher than the market rate.

16:53This is central banking 101. The solution was kind of hiding in plain sight. In all those decades, the Fed was saying one thing and doing another. Don't borrow for a month, but here you go, it's cheaper. But now they simplify things. They get rid of some of the rules they'd added, like the one where you had to exhaust all your other options first. And instead, the Fed conveys their message with an economic signal with this higher rate. So after nearly 100 years of tinkering, the Fed seems basically happy with the structure of the discount window. A little stigma, maybe, but not too much. OK, so what about like now?

17:34How is it working? No reason, just curious. That's after the break.

17:42This message comes from Capital One with the Quicksilver card. Earn unlimited 1.5 % cash back on every purchase, every day. What's in your wallet? Terms apply. See CapitalOne.com for details. This message comes from Charles Schwab. When it comes to managing your wealth, Schwab gives you more choices, like full-service wealth management and advice when you need it. You can also invest on your own and trade on Thinkorswim. Visit schwab.com to learn more. So now, today, we have just come through a moment of banking turmoil. How did the discount window do? To talk about this, we called Yesha Yadev, a professor at Vanderbilt Law and a friend of the show.

18:25I think a lot about the Fed. I think a lot about the banks. And I think a lot about what can go wrong. I hate to say it, but I think academics like me, we kind of love it when things go wrong because it means that we can actually feel relevant once in a while. Yesha told us back in 2022, before any systemic banking panic energy entered the chat, the banks started borrowing from the discount window. So there was a little bump in folks using it in November 2022, and that can potentially be explained by the rate rises that we're under at present. In 2022, the Fed started raising interest rates fast and aggressively.

19:00And when interest rates go up, bond prices go down. Last year was the worst year ever for the U.S. bond market, including U.S. government bonds. You know who holds a lot of U.S. government bonds? Banks. And some banks were holding a lot, a lot of these government bonds. So they were feeling the stress. And they borrowed from the discount window. Which is good. That's what's supposed to happen. So the window is doing well. Then, in March, things got much more. Fast and aggressively more. Three banks collapsed. Silvergate, Signature Bank, and the biggie, Silicon Valley Bank. It was a bad time for your name to start with S.

19:41We have not had one of these runs for a very long time. And so it's interesting to see it happen in real time and not just in real time. It's interesting to see it happen after a couple of twitcher strokes, one hectic weekend, and then the banking system seemed to fall apart in the space of a week. This is not the Fed or the discount window's first rodeo. They've learned a few tricks from previous stressful banking moments. Case study number one comes from the Great Recession. Yesha says that in 2007 and 2008, the Fed is looking at the discount window and is like, OK, we are literally going into a bank crisis.

20:19It's a perfect ideal time for a perfect ideal window, but the banks aren't using it. Because of stigma. Banking, as we can see, is a confidence game. That banks have to ensure that other people have confidence in them, that the public has confidence in them. And at this moment, the banks are terrified that they are going to be perceived as unstable, as weak, as needing help. If word gets out that they borrowed from the discount window, that might be all the market needs to absolutely freak everyone out and spark a real, real bank run. So the banks are refusing to ask for help. They are trying to tough it out.

21:01Banks are super reluctant to use the discount window. And sometimes they're willing to take the long way around to avoid being caught in this walk of shame. In 2007, the Fed decides to give banks an out. They build this special new program for banks to get money, something tailor-made for this particular crisis. And that gets the money flowing. And just a few weeks ago, the Fed did something similar. It opened a new special not-discount window program called the Bank Term Funding Program. And this new not-window is specially tailored just for this moment. It lets the banks use the devalued bonds that are at the heart of this particular freakout to get money.

21:45The Fed will take those at face value. It is a very, very sweet deal for the banks. The Fed has apparently decided that that's what's necessary. So that's, I think, some of the rationale behind the bank term lending facility. This is a way for the Fed to create a little plaster cost over that risk. OK, so that was case study number one. Case study number two, 2020, the short, sharp shock of the COVID recession. A lot of banks need extra money to weather the downturn. And the virus is not a bank management failure. so the banks should not feel any shame borrowing from the discount window. But just to be safe, the Fed pulls out a tool not from any central banking playbook, but from high school.

22:29They get the most popular kids in school to use the discount window and then tell everybody that they use the discount window. What happened was that to get folks to take the loan, they got the big banks to all borrow from the discount window to ease that sense of stigma and shame because it felt like the big banks are doing it. So can we. That's really funny. Peer pressure is so powerful. Peer pressure is so powerful, especially with the big cats. The banks borrow. Things go okay. The banking system makes it. And just now, in March 2023, we saw the good side of peer pressure in action again. Things were so stressful, suddenly everyone needed the window.

23:11The week of March 16th, that discount window was used a lot. And at that point, the shame is gone because everyone needs it. the Fed is encouraging you to take it. And so it's clear that at this point, the stigma is going to be much, much less because everyone is trying to get in the door to use it and essentially to stay alive. In one week, bank borrowing from the discount window went from$5 billion to a record setting$153 billion. So one thing we've learned is that it's way easier to use this window when you feel like you're not the only one. It seems like in this moment, the discount window itself is working pretty well.

23:49Banks were using it when they needed it. All that tinkering maybe worked. We've gotten the discount window stigma versus not stigma to a pretty reasonable place. What we're trying to really do is ensure that when it comes to thinking about situations where there's a cash crunch, that we don't cover that situation in a whole lot of moral reproach and making people feel bad about themselves, that we understand the character of the industry as being inherently risky and then use the discount window to do its job. What the Fed has also learned is that the discount window, while it is necessary and may even be in its optimal structure, it alone is not sufficient to rescue the banking system.

24:30The discount window is a great tool, but it's kind of one size fits all. So sometimes, often, other things are going to be necessary to meet the moment. More precise, more tailored tools. because the banking system, bless it, is not going to stop coming up with new products and new risks and new problems.

24:57This episode was produced by Emma Peasley with help from Willow Rubin. It was engineered by Catherine Silva, fact-checked by Sarah Juarez, and edited by Sally Hell. Jess Zhang is our acting executive producer. I'm Jeff Guo. And I'm Mary Childs. This is NPR. Thanks for listening.

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