How Banks Are Adjusting to Fed's Latest Rate Cut

The Federal Reserve's recent rate cut is encouraging U.S. banks to reconsider their reliance on the Bank Term Funding Program (BTFP), which offered low-cost borrowing to institutions during times of financial stress. As liquidity conditions normalize, banks are expected to gradually repay the loans they took from this facility, removing substantial amounts of liquidity from the financial system.

The BTFP, which peaked at $168 billion in loans, allowed banks to secure one-year borrowing at favorable rates. However, with the Fed’s recent rate cut, this program now appears less attractive to financial institutions. The BTFP’s outstanding balance fell 44% last week to $94.8 billion, and further reductions are expected in the coming months.

• Banks are likely to repay BTFP loans early following the Fed’s rate cut.
• BTFP balances have dropped 44% from their peak, now at $94.8 billion.
• The facility allowed banks to borrow using U.S. Treasuries and agency debt as collateral at favorable rates.

• The Fed’s rate cut makes BTFP less attractive, encouraging early loan repayments.
• Repayments could remove liquidity from the financial system, impacting money markets.
• Banks may turn to FHLB or commercial paper for alternative funding sources.

• Banks are expected to seek alternative funding as they exit the BTFP.
• The Federal Reserve’s quantitative tightening plan will continue unaffected.

Banks' ability to repay these loans may have a short-term effect on market liquidity. However, the repayments are unlikely to disrupt the Federal Reserve’s broader strategy to reduce its balance sheet, a process known as quantitative tightening. Analysts expect the Fed to continue on its current course, with no indication that early BTFP repayments will accelerate or alter the plan.

As BTFP loans are repaid, banks will likely shift towards other funding sources, including the Federal Home Loan Bank and commercial paper. While the Fed’s quantitative tightening efforts continue, financial institutions will adjust their borrowing strategies to align with the changing cost structure in the lending market.