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April 13, 2011

Why Did U.S. Branches of Foreign Banks Borrow at the Discount Window during the Crisis?

Linda S. Goldberg and David R. Skeie

To help contain the economic damage caused by the recent financial crisis, the Federal Reserve extended large amounts of liquidity to financial firms through traditional lending facilities such as the discount window as well as through newly designed facilities. Recently released Federal Reserve data on discount window borrowing show that some U.S. branches and agencies of foreign banks were among the most active users of the window. In this post, we explain why U.S. branches borrow at the discount window. We also discuss two main reasons why these branches had a large need for dollars during the crisis and how discount window loans to them helped stabilize the financial system and the real economy in the United States.

U.S. Branches of Foreign Banks

A U.S. branch of a foreign bank is not a separate legal entity, but a part of the bank. To distinguish the foreign bank from its U.S. branch, we refer to the foreign bank as the “parent bank.” The U.S. branch is supervised by the Federal Reserve and the U.S. banking regulator (either the Office of the Comptroller of the Currency or a state banking department) that issued its banking license. Although a U.S. branch may take uninsured deposits and make loans in the United States, it typically is oriented toward business and corporate clients, not households. At the start of the recent crisis in 2007:Q2, U.S. branches had nearly $500 billion in outstanding loans.

U.S. branches differ from domestic banks in two key ways that affect their need for liquidity. First, most U.S. branches are not allowed to offer deposits insured by the Federal Deposit Insurance Corporation. Thus, they lack access to the stable source of funds represented by households’ checking, savings, and other transaction accounts. Second, the branches have funding and investment activities that are often closely tied to their parent banks, including sending, or “upstreaming,” dollars raised in the United States to their parent banks or receiving “downstreamed” dollar support from them. (For more on flows from U.S. affiliates, see the study by Cetorelli and Goldberg.) In some cases, the parent bank’s investment decisions are implemented by its offices in the United States. In others, funds raised in the United States are channeled back to the parent bank, which then makes investment decisions and implements these decisions, including lending to U.S. customers or investing funds in other U.S. markets or financial instruments. How and where this whole process plays out depends on the business model of each parent bank. Moreover, these upstreaming and downstreaming actions are not unique to foreign banks in U.S. markets. Many U.S. banks with global operations have foreign branches or subsidiaries abroad that make the same types of decisions.

Why U.S. Branches of Foreign Banks Can Access the Discount Window

The Federal Reserve Act requires discount window credit to be made on a nondiscriminatory basis to institutions that are eligible to borrow, including U.S. branches of foreign banks. These branches must meet the same soundness criteria as U.S. commercial banks and thrifts, including being adequately capitalized and having appropriate supervisory ratings. Like U.S. banks, U.S. branches must comply with the guidelines governing discount window lending; to borrow, the branches must maintain and pledge a sufficient amount of eligible collateral to their Reserve Bank. (For more on the discount window, see the post by Santos and Peristiani.)

Borrowing Dollars during the Crisis

During the financial crisis, many institutions addressed their funding challenges by borrowing from the discount window. U.S. branches borrowed from the window for two reasons: the parent banks had recently expanded dollar holdings that required continued funding, and the “wholesale funding” markets—such as the money markets and the markets for currency swaps and brokered funds—that they typically relied on for dollar funding were severely disrupted.

Foreign banks’ expanded dollar investments. In the decade before the crisis, dollar assets, such as mortgage-backed securities, accounted for half the growth in European banks’ foreign exposures over the 2000-07 period (McGuire and von Peter 2009). Indeed, banks’ on-balance-sheet dollar exposures in the European Union, United Kingdom, and Switzerland were estimated to exceed $8 trillion in 2008. This growth in dollar exposures has been attributed to a number of factors. Among them, bank regulatory frameworks allowed European banks to provide financing for many of the mortgage assets being created in the United States. The way in which these assets were funded became problematic during the crisis.

Reliance on short-term dollar funding. Prior to the crisis, foreign banks raised much of the dollars they needed by borrowing in short-term dollar markets, either directly or (increasingly) through their U.S. branches that upstreamed the funds to them. They relied on central bank deposits as well as various market-based sources of funds, including money market funds, brokered deposits, the foreign exchange swap market, and the interbank market. Compared with domestic banks, both foreign bank parents and their U.S. branches relied more heavily on wholesale dollar funding because they lacked access to the stable dollar deposits of individuals and households.

In the United States, the discount window is a critical liquidity backstop for banks at all times. The window was especially important during the crisis for those banks that depend on the wholesale funding markets. When these markets were disrupted, U.S. branches of foreign banks and other U.S. institutions that had relied on wholesale funds could not raise enough dollars, so they used the discount window extensively. These U.S. branches borrowed to meet their direct needs while serving as critical providers of dollar funding to their parent banks. Branch lending to parent banks grew from $329 billion in 2007:Q3 to $587 billion in 2008:Q3, according to Federal Reserve statistics. As the Federal Reserve engaged in dollar liquidity swaps with foreign central banks, the parent banks were able to borrow dollars directly from their central banks. U.S. branch funding of parent banks thus fell to $150 billion by 2008:Q4, and U.S. branches decreased their reliance on dollar funding at the discount window. (For more on dollar liquidity swaps, see the New York Fed EPR article by Goldberg, Kennedy, and Miu.)

The Effect on Financial Markets and Loan Availability in the United States

Discount window lending to U.S. branches of foreign banks and dollar funding by branches to parent banks helped to mitigate the economic impact of the crisis in the United States and abroad by containing financial market disruptions, supporting loan availability for companies, and maintaining foreign investment flows into U.S. companies and assets.

Without the backstop liquidity provided by the discount window, foreign banks that faced large and fluctuating demand for dollar funding would have further driven up the level and volatility of money market interest rates, including the critical federal funds rate, the Eurodollar rate, and Libor (the London interbank offered rate). Higher rates and volatility would have increased distress for U.S. financial firms and U.S. businesses that depend on money market funding. These pressures would have been reflected in higher interest rates and reduced bank lending, bank credit lines, and commercial paper in the United States. Moreover, further volatility in dollar funding markets could have disrupted the Federal Reserve’s ability to implement monetary policy, which requires stabilizing the federal funds rate at the policy target set by the Federal Open Market Committee.

Lending to U.S. branches of foreign banks also mitigated the degree to which the banks needed to engage in “fire sales” o
f assets to meet their liquidity needs. As discussed broadly by policymakers, liquidity injections helped break the vicious downward price spirals on assets and the pressures on bank capital that were further stressing global markets.

In addition to containing further disruptions in the broad financial system, the provision of liquidity to U.S. branches of foreign banks supported lending to U.S. firms. In markets that are increasingly integrated, U.S. branches are an important part of the U.S. financial system. They channel a sizable portion of the funds raised here and by their parent organizations back to the United States through their investments. In addition, foreign banks support the trade of other countries with the United States, facilitate international purchases of U.S. financial assets and foreign direct investment in the country, and deepen global financial markets for dollar assets. (For more, see the report by the Bank for International Settlements.)

In sum, discount window lending to U.S. branches of foreign banks supports the U.S. economy by helping to maintain the operation of dollar-based money and credit markets and preserving the flow of dollar credit to the U.S. economy.

The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author(s).


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Thanks for the comment. The general rationale for a central bank to provide liquidity against illiquid collateral is discussed in the March 30 Liberty Street Economics post by Santos and Peristiani. As we explain in our post, providing dollar liquidity that ends up being used overseas benefits the U.S. economy by supporting international trade in U.S. dollar goods, international investment in U.S. dollar assets and U.S. companies, and international U.S. dollar-based financial money markets and foreign exchange markets. Here, we will first briefly discuss the types of collateral taken at the discount window, and then comment on the regulation of bank liquidity. Details on the types of collateral that can be pledged at the Discount Window are addressed more fully elsewhere (see In general terms, and drawing on some details from that link, assets that are commonly pledged to secure discount window advances include: Government securities; Agency debt and mortgage-backed securities; Municipal bonds; Collateralized mortgage obligations; Asset-backed securities; Corporate bonds; Money market instruments; Residential real estate loans; Commercial, industrial, or agricultural loans; Commercial real estate loans; and Consumer loans. All securities must be rated investment grade; for some asset types, only “AAA” rated securities are accepted. In general, the Federal Reserve seeks to value all pledged collateral at an internal fair market value estimate. Margins are applied to the Federal Reserve’s internal fair market value estimates and are based on risk characteristics of the pledged asset as well as the anticipated volatility of the fair market value of the pledged asset over an estimated liquidation period. During times of stress, it would be beneficial for banks to have more liquid assets on their balance sheets. Enhanced capital and liquidity regimes for banks in the United States and abroad are among the important steps that are needed to make the financial system more robust and resilient, and are features of the Basel 3 requirements to which U.S. and foreign banks will be subject in the future (for more on the requirements, see the March 28 Liberty Street Economics post by Hirtle). A number of these steps were presented in a speech earlier this week by Federal Reserve Bank of New York President William Dudley (

Why should the Federal Reserve provide loans on illiquid collateral from a bank which primarily uses the funds overseas? I presume that the collateral used at the discount window was less then immediately liquid. Why not require that these branches hold sufficient liquid collateral for crisis situations? And I would suggest that U.S. Banks should also be required to hold more liquid assets for times of stress.

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