United States: Y2K Special Liquidity Facility

The Fed first proposed the SLF on May 21, 1999, in a proposed rule change (Board of Governors 1999f). The Fed received 93 comments from financial institutions through July 2, 1999, with all but three supporting the proposal (Board of Governors 1999a).

In the initial proposal, the SLF was to be active from November 1, 1999, to April 7, 2000 (Board of Governors 1999a). However, in response to comments, the Fed started the facility a month earlier (Board of Governors 1999a). The Fed published the final rule in the Federal Register on August 2, 1999 (Board of Governors 1999e).

The Fed created the facility to “ensure that depository institutions [had] adequate liquidity to meet any unusual demands in the period around the period date change,” though the Fed designed the facility to have a spread “high enough to encourage institutions to make private-sector arrangements” outside the discount window while still providing a backstop (Board of Governors 1999a; Board of Governors 1999d). In the FOMC discussion, committee members said they expected the SLF to provide “a means for the System’s balance sheet to expand as we lend to small banks, who may be perceived to be less well prepared than the large banks to handle any Y2K problems” (FOMC 1999, 4).

The SLF operated alongside the discount window and derived its legal authority from a temporary amendment to Regulation A (Board of Governors 1999e). The Fed issues Regulation A under the authority of sections 10A, 10B, 11(i), 11(j), 13, 13A, 14(d) and 19 of the Federal Reserve Act (Federal Reserve Act 1913). On May 27, 1999, the Fed first published a proposed update to Regulation A in the Federal Register containing the proposed rule for comment (Board of Governors 1999d). On August 2, 1999, the Fed published the final rule in the Federal Register to establish the SLF and specify its terms of operation (Board of Governors 1999e, 64:4).

The SLF was part of the Fed’s broad, multi-year preparations for the century date change (Kelley 2000). On August 24, 1999, one month after the Federal Reserve Board announced the SLF, the FOMC agreed on a number of further measures. These measures included: expanded accepted collateral at the discount window, authorization to execute repurchase agreements with up to 90-day maturities, and the Standby Financing Facility (SFF) (FRBNY 1999). In a press release on September 8, 1999, the FRBNY announced these measures. It said their purpose was to facilitate “the smooth functioning of money and financing markets and . . . to manage banking system reserves” with respect to Y2K (FRBNY 1999).

The Fed authorized the SLF, announcing it through the Federal Register on August 2, 1999 (Board of Governors 1999e). Disclosure and oversight for the SLF were consistent with open market operations disclosure: the Fed published aggregated data in its weekly H.4.1 reports (FRBNY 2000, 4). The SLF was administered by the Federal Reserve Banks alongside the discount window (Board of Governors 1999e).

The SLF was managed by the regional Federal Reserve Banks. An eligible institution could approach its regional Bank to receive a loan as long as the institution could fully collateralize the loan, as determined by the regional Bank (Board of Governors 1999e). There were no minimum or maximum limits imposed on a borrowing bank (Board of Governors 1999e).

In the proposed update to Regulation A, the Fed suggested that the SLF would be available only to depository institutions in sound financial condition (Board of Governors 1999d). Under the proposal, depository institutions that were undercapitalized or critically undercapitalized, as per ratios set under the Federal Deposit Insurance Act, would not be able to access the SLF. The Fed similarly proposed that only credit unions with a net worth ratio of at least six percent (“adequately capitalized” as per the Federal Credit Union Act) would qualify. Several commentators on the proposal warned that “denying access to [the] institutions [that did not meet these criteria] could cause a public reaction that would increase the institution’s vulnerability and precipitate customer withdrawals” (Board of Governors 1999e, 64:41767).

In response to comments, the Fed left the determination of “soundness” at the discretion of the Reserve Bank. Eligible institutions for the SLF were depository institutions that were in “sound financial condition in the judgment of the lending Federal Reserve Bank” (Board of Governors 1999e, 64:41766). In determining soundness, the Reserve Bank was to “take into account whether the decline owed to temporary balance sheet distortions with the century date change, as well as the financial conditions of the institution before those distortions occurred” (Board of Governors 1999e).

The SLF was funded through the Fed’s balance sheet (Board of Governors n.d.a).

The SLF did not have a pre-determined program size (Board of Governors 1999e). Daily borrowing peaked at $1.2 billion on December 30, 1999. Average daily drawdowns are displayed in Figure 2.

The Fed stated that borrowers at the SLF would be able to “adjust the amount they borrow as frequently as they desire” as all loans were fully collateralized and charged a penalty rate (Board of Governors 1999e). Banks were therefore limited only by the quantity of eligible collateral they had.

The SLF charged 150bps over the FOMC’s targeted federal funds rate (Board of Governors 1999d, 64:41766). Between October 1, 1999, and November 16, 1999, the SLF charged a rate of 6.75% (Board of Governors 1999b). This was raised to 7% on November 16, 1999, and then again to 7.25% on February 2, 2000, in line with revisions to the FOMC’s target for the FFR (Board of Governors 1999b).

Solicited comments from market participants generally advocated for a lower spread over the FFR (Board of Governors 1999e, 64:41766). About 70% of comments suggested that the spread be decreased, with 20% advocating a 50bps spread. Commentators gave a few reasons for favoring a lower spread. Some stated that the penalty would put an undue burden on financial institutions, as the rate significantly exceeded their typical cost of funds. Others stated that the penalty rate would discourage use until “liquidity problems had become acute.” Some emphasized that the rate would contribute to stigma, discouraging use (Board of Governors 1999e, 64:41766).

Ultimately, however, the Fed set the SLF’s spread at 150bps, saying that:

The Fed stated that one difficulty in selecting the spread was that there were “no close analogues to the facility against which to compare the pricing,” given that the SLF offered loans without fees and with repayment at any time over the life of the facility without penalty (Board of Governors 1999e). The Fed compared SLF loans to some Federal Home Loan Bank (FHLB) advances to members which were priced comparably. The Fed also compared the 150 basis point spread to the pricing small banks faced through secured lines of credit with commercial banks (Board of Governors 1999e).

Eligible collateral for the SLF was identical to the discount window (Board of Governors 1999e). Several commenters on the draft regulation for the SLF requested expansions of eligible collateral beyond the collateral accepted at the discount window, but the Fed ultimately kept collateral requirements identical with the discount window. Borrowers were required to pre-position collateral, to have appropriate authorization to access credit the day of a request, and all loans were to be “fully collateralized to the satisfaction of the Reserve Bank” (Board of Governors 1999e). The Board stated, however, that “Staff [would] work aggressively to expand the range of acceptable collateral and to make collateral procedures more expeditious and flexible” (Board of Governors 1999e).

SLF loans could be outstanding “until the program expires,” which was April 7, 2000, so they had a maturity of up to six months (Board of Governors 1999e). However, section 10B of the Federal Reserve Act requires that discount-window loans not exceed four months; as the SLF was authorized under discount window authority, it was subject to section 10B (Board of Governors 1999e). In the Regulation-A amendment specifying the SLF’s operations, the Fed stated that as the loans were “payable on demand . . . their maturities do not exceed four months” (Board of Governors 1999e).

SLF loans differed from adjustment credit in a few ways.^FNPrior to 2003, adjustment credit allowed banks to meet reserve requirements on a short-term (typically overnight) basis by borrowing from their Federal Reserve Bank. Interest rates for adjustment credits were typically lower than the federal funds rate. Because of stigma at the discount window, very few banks borrowed adjustment credit from the Fed (FRBNY 2015). First, borrowers at the SLF were not required to prove that they had exhausted all alternative liquidity sources. Second, the use of SLF funds was not limited in the same way as adjustment credit. Third, loans from the SLF did not come with a requirement that “credit be repaid expeditiously; credit [could] remain outstanding until the program” expired (Board of Governors 1999e, 64:41678).

The Fed did not explicitly mention the impact of the SLF on monetary policy; it did not discuss plans to sterilize operations in authorizing the facility.

As part of the regulatory process, the Fed took comment from market participants on the proposed design of the facility and responded to proposed changes including changing the eligibility restrictions to make the program more accessible and lowering the penalty rate (Board of Governors 1999e). The Fed also created the SFF, a facility that sold options on repurchase agreements to primary dealers to ensure market functioning through the century date change (see Leonard, 2022).

Some other countries also took special measures in anticipation of the century date change. The Bank of Canada created its own Special Liquidity Facility, with similar characteristics to the Fed’s SLF.^FNThe Bank of Canada’s Special Liquidity Facility was available to all financial institutions that used the Large Value Transfer System (LVTS) (Bank of Canada 1999). The facility was created November 1, 1999, and designed to close March 31, 2000. It accepted a “wide range of collateral including securities and assignments on the loan portfolio of the borrowing institution” and charged an interest rate equal to the Bank Rate plus 125 basis points. Like the SLF, loans could be repaid throughout the facility’s lifespan, so they had a maximum maturity of five months (Bank of Canada 1999). The Bank of Canada also expanded the range of collateral accepted in its standard overnight repo operations, like the Fed (Bank of Canada 1999). The Bank of England issued special Treasury bills that matured on December 31, 1999, expanded the range of repo maturities to 90 days, and expanded the range of accepted collateral (Sundaresan and Wang 2006, 22). Sundaresan and Wang could not find an example of another central bank that sold options like the Fed’s SFF (Sundaresan and Wang 2006, 22).

In late 1995, the Fed created the Century Date Change (CDC) project to coordinate Y2K readiness across the Federal Reserve system. As part of this plan, the CDC project reviewed every bank by mid-1998 to assess readiness (Kelley 1997). Between 1997 and 1999, the Fed published contingency planning guides, brochures on bank readiness, and press releases explaining the impact of the century date change (Board of Governors 1999c).

The Fed held a Year 2000 Summit to discuss the century date change event, and the actions that the financial sector and the Fed had taken to prepare for the event. Chairman Greenspan noted that while the financial sector had generally taken the necessary steps to prepare, and that “the technical breakdowns that might occur as a consequence of the CDC are readily containable,” there was evidence that borrowers and lenders were building up liquid assets to reduce reliance on credit markets. He said that the SLF and the SFF “should help to ensure an ample supply of liquidity and relieve funding pressures” (Greenspan 1999).

A Fed official spoke to the Wall Street Journal following the announcement of the facility and explained that the facility would help “banks under pressure that ordinarily wouldn’t be under pressure” (Newswires 1999).

The Fed published aggregate borrowing from the SLF in its weekly H.4.1 releases for the duration of the facility’s operation (Board of Governors n.d.a). Disclosure and oversight for the SLF were consistent with open market operations disclosures.

Prior to 2003, discount-window adjustment credit was available for depository institutions at rates below the effective federal funds rate (Carlson and Rose 2017). However, to limit arbitrage, the Fed required that institutions attempt to obtain funding from private sources before accessing discount-window credit. This likely exacerbated the stigma associated with the discount window: to access funds, a distressed institution had to reveal to other market participants that it faced funding shortfalls (Carlson and Rose 2017).

Likely to limit stigma, financial institutions did not need to “exhaust alternative liquidity sources” to access SLF funds (Board of Governors 1999e, 64:41678). Sources at FRBNY indicated that the Fed was aware of stigma and designed the facility to mitigate its effect. In 2003, the Fed implemented changes to the discount window to address stigma—eliminating the requirement that institutions exhaust private funding sources and instead implementing a penalty rate—that mirrored the design of the SLF (Board of Governors 2002, 8).

The SLF was announced with an end-date of April 7, 2000, and expired on that date (Board of Governors 1999e).