A working paper from the New York Federal Reserve Bank provides empirical evidence of the existence, size, and the economic impact of the stigma associated with banks borrowing from the Federal Reserve's discount window facility.
Historically, banks' utilization of the discount window has been low, even when faced with severe liquidity shortages. For example, at the onset of the financial crisis in 2007, few banks accessed the discount window, despite several policy changes by the Federal Reserve to encourage borrowing from the discount window.
There are two potential explanations as to the low level of bank participation at the discount window in the Fall of 2007. The first explanation was that banks wanted to avoid the stigma associated with such borrowings. The other explanation was that banks could potentially borrow elsewhere at equal or cheaper rates.
To identify whether there was a stigma associated with borrowing from the Fed's discount window, the authors compare banks borrowing behavior at the Fed’s Term Auction Facility (TAF) and the discount window. The TAF was a liquidity facility created by the Fed in December 2007 with virtually the same eligibility and collateral criteria as the discount window.
Using bid level data of TAF participation, the authors found that many banks submitted bids above the prevailing discount rate at TAF auctions throughout the crisis. In particular, banks consistently bid above the discount rate for a period of six months in 2008. This willingness to bid above the discount rate provides strong evidence that a stigma associated with discount window borrowings does exist.
Next the researchers measured the size of the stigma and found that, during the height of the financial crisis, banks were willing to pay an average premium of at least 37 basis points (and 150 basis points after Lehman’s bankruptcy) to borrow from the Term Auction Facility rather than from the discount window.
To read the paper click here.