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Federal Reserve Approves Final Rule on 13 (3) Emergency Lending

Federal Reserve Board of Governors

Open Meeting – Final Amendments to Emergency Lending Provisions

Monday, November 30, 2015 

Key Topics & Takeaways

  • Final Rule Approved: The Board of Governors approved the final rule for its emergency lending procedures under Section 13(3) of the Federal Reserve Act in a 5-0 vote.
  • Notable Changes: Laurie Schaffer outlined notable changes from the original proposal, including: 1) a requirement that at least five persons be eligible to participate in the program or facility for it to be considered “broad-based”; and 2) a broader definition of insolvency to include failure to pay undisputed debts as they become due during the 90 days before borrowing; among others.
  • Emergency Lending and Title II: Governor Tarullo said that at the time of the financial crisis, the Board saw a choice between using emergency lending and watching the disorderly failure of institutions, but that this is no longer the tradeoff since Congress created Title II and resolution planning. 

Speakers

Chair Yellen Opening Statement

In her opening statement, Federal Reserve Chair Janet Yellen called emergency lending a “critical tool” to help mitigate extraordinary pressures in financial markets that would otherwise have severe consequences for the economy. She noted that the Fed has long had this authority, but has used it sparingly and only in severe crises. The Dodd-Frank Act, she explained, involved a congressional review of the scope of the Federal Reserve’s emergency lending authority and required that the Fed make “significant modifications” that restrict the tool’s use to broad-based facilities and programs designed to provide liquidity to the financial system. She added that in place of the Fed’s previous ability to lend to specific failing firms, Congress has enacted a framework for orderly resolution and provisions that encourage large financial institutions to develop resolution plans through bankruptcy. 

Yellen added that the Federal Reserve received helpful and constructive comments from many sources that were considered as changes were made to the original proposed rule to ensure that it is applied in a manner that is consistent with the intent of Congress. 

Staff Presentation

Associate General Counsel Laurie Schaffer gave a brief overview of the changes to the original Fed proposal included in the final rule, which she said were constructed jointly with staff from the Treasury Department. The most notable changes included: 1) requiring that at least five persons be eligible to participate in the program or facility for it to be considered “broad-based”; 2) broadening the definition of insolvency to include failure to pay undisputed debts as they become due during the 90 days before borrowing; 3) clarifying that solvent firms cannot borrow for the purpose of passing the proceeds of emergency loans to insolvent firms; 4) specifying that the emergency loans would be made at a penalty rate that exceeds the market rate for such loans; 5) requiring review by the Board of Governors every six months of whether the program or facility should be terminated; 6) limiting to one year the initial duration of an emergency credit program and require a Board vote and the approval of the Treasury Secretary for any renewal; and 7) requiring an acceleration of the loan, including interest, fees and penalties, for willful misrepresentation regarding the solvency of a borrower. 

Governor Questions and Comments

Yellen noted that some commenters proposed that the Fed establish a fixed spread over the London Interbank Offered Rate (LIBOR) or a different market rate for the penalty rate, and asked why the final rule does not do so. Deputy Director of Monetary Affairs Bill Nelson answered that during the crisis, the Federal Reserve was faced with differing circumstances where different premium rates were appropriate. He explained that it is the staff’s belief that maintaining the current policy would give the Fed flexibility consistent with speedy repayment. General Counsel Scott Alvarez stressed that the penalty rate will encourage quick repayment. 

Vice Chairman Stanley Fischer asked how the staff arrived at a minimum of five persons in its clarification of the definition of “broad-based.” Schaffer replied that the number comes from legislation introduced in Congress. 

Fischer then asked for a clarification of what it means that lending facilities will close after one year. Alvarez answered that there would be no further extensions of credit from that facility after a year unless the Board of Governors and the Treasury Secretary agree it is needed. 

Governor Daniel Tarullo commented that there has been a longstanding tension between containing moral hazard and wanting to retain flexibility to provide liquidity when needed. He said that at the time of the financial crisis, the Board had to choose between using emergency lending and watching the disorderly failure of institutions, but that this is no longer the case since Congress enacted Title II and resolution planning. He said these reforms should be looked at together as a package, and stated that the final rule does a “much better job” of balancing the tradeoffs. 

Governor Jerome Powell noted that some commenters suggested that there be limits on the type of collateral the Federal Reserve could accept, and asked why such limits were not included. Alvarez answered that the Federal Reserve has accepted a wide set of collateral in bank and non-bank lending over the years. He stated that the rule requires that the Fed make a valuation of collateral and ensure that it is sufficient to protect taxpayers from losses, and that the Fed has never had any losses in liquidity extension to date. 

Final Vote

The Board of Governors approved the final rule in a 5-0 vote. 

For more information on this event, please click here.