GregoryLaraL3L

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# What is the Bank Term Funding Program?

The Bank Term Funding Program or BTFP is a service offered by the Federal Reserve. It's designed to loan money to banks in case they are running low on reserves or want to money for any other reason. The program was created in March 2023 after a series of bank runs caused three banks in the USA to collapse. The BTFP loans money at a fixed interest rate that is typically relatively high compared to loans from banks other than the Federal Reserve. You can view the current interest rate policy for the BTFP [here](https://www.frbdiscountwindow.org/).

# It is surprisingly popular

Even though BTFP loans are new and have relatively high interest rates, they have quickly become *by far* the most popular type of loan offered by the Federal Reserve. In the Federal Reserve's [latest balance sheet report](https://www.federalreserve.gov/releases/h41/20230928/) they point out that banks currently owe the Federal Reserve $3 billion due to taking out "Primary Credit" loans, $5 billion due to the Paycheck Protection Program, and a whopping $108 billion due to BTFP loans. The BTFP is more than 20 times more popular the Federal Reserve's next most popular loan offering.

So why is the BTFP so popular if it loans money at higher interest rates than banks can get elsewhere? Here are three reasons:

- Enhanced secrecy
- Zero penalties
- Any bank can unilaterally *lower* the BTFP's nominal interest rate by a massive amount

The last one is a doozy but let's start with "enhanced secrecy."

# Enhanced secrecy

Normally, when a bank needs some money and calls up the Federal Reserve for a loan, it's a bad sign. Most banks, when necessary, borrow money from their peers, i.e. other regional banks, because they offer lower interest rates than the Federal Reserve does. If a bank has to go to the Federal Reserve, with its higher rates, that suggests their peers wouldn't work with them. Maybe their peers don't trust them to repay the loan, or they think they are about to go bankrupt. The Federal Reserve is only supposed to be a "lender of last resort" if a bank can't get a loan anywhere else.

To ensure that every bank "knows" one of their peers sought help from the central bank, the Federal Reserve requires banks to give notice in a "Call Report" whenever they borrow money from the Federal Reserve. But not so with the BTFP. In April 2023, the Federal Reserve clarified that banks can borrow from the BTFP without telling their peers:

> How will borrowings from the Program be reflected on an eligible borrower’s call reports? ... There are no additional or revised reporting requirements for the Call Report with respect to [BTFP] borrowings. ... [They] are not reported separately on the Call Report. These amounts are included within line items that aggregate various other categories of borrowings. [source](https://www.federalreserve.gov/financial-stability/files/bank-term-funding-program-faqs.pdf)

This is even better than borrowing from your peers. If Struggling Bank 243 asked Bank of America for a loan to help them through next quarter, at least Bank of America would know that bank is struggling, and maybe try to buy them out, or "punch down" to eliminate the competition. But if they borrow from the BTFP, the Federal Reserve will keep that quiet. What a deal!

# Zero penalties

Here's another fascinating line from that document:

> Are there any penalties associated with prepayment of a [BTFP loan]? ... No. [source](https://www.federalreserve.gov/financial-stability/files/bank-term-funding-program-faqs.pdf)

Sometimes, when you take out a loan, you decide to pay it off early, and this is called a prepayment. (I remember my mother paying extra on her mortgage payments so she could own her home sooner.) Many lenders don't like this because it can result in lost future revenue. Borrowers who just make the minimum payments have more opportunities to miss one, which allows lenders to hike up their interest payments. And if an interest rate is not fixed, but varies according to market conditions, lenders like to keep borrowers on the hook for longer if interest rates are expected to rise.

To discourage prepayments, lenders sometimes charge a penalty. But the BTFP doesn't. You can pay off part or all of your loan early and not get fined for doing so. Once again, a good deal! If you're a struggling bank, maybe your peers would take advantage of that by penalizing you if you try to get back on your feet quickly. But the BTFP won't. So it might be worth paying a slightly higher interest rate if you think you'll have a lower overall cost due to not having any penalties.

# Hidden lower rates

And here's the big reason: If I borrowed $100 from the BTFP at a 10% interest rate, I would owe $110 next year, meaning the total cost of the loan should be $10 in interest payments. If I decided to prepay half the principle 182 days later, I would have to give them $50, but also a bit more, because of this line:

> if the borrower prepays some or all of a loan, [accrued interest will be charged] the day the borrower makes this prepayment. [source](https://www.federalreserve.gov/financial-stability/files/bank-term-funding-program-faqs.pdf)

This is how that interest is calculated (the formula is given in the same source document):

(100×(10%÷365))×182 = $4.99

So instead of paying $50, I have to pay $54.99. But now, how much is left over that I still have to pay? To answer that, this line comes into play:

> Interest [on BTFP loans] does not compound; it accrues based only on the outstanding balance of the advance. [source](https://www.federalreserve.gov/financial-stability/files/bank-term-funding-program-faqs.pdf)

Well, after I paid my $54.99, the "outstanding balance of the advance" is the remaining $50 on the principle. So my interest payments have to be recalculated:

(50×(10%÷365))×183 = $2.76

Or, if you think they should count the outstanding balance as $55.01 remaining since I previously owed them $110 and only paid off $54.99 of that, here is the calculation:

(55.01×(10%÷365))×183 = $2.76

Either way, when day 365 arrives, the cost of the loan will not sum to $10 in interest payments, it will only sum to $4.99 + $2.76 = $7.75 -- a massive 2.25% reduction in the interest rate!

Therefore, prepaying BTFP loans is a way for banks to *unilaterally lower* the nominal interest rate on their borrowings.

So banks have a HUGE reason to prefer BTFP loans: their interest rate is not as high as it looks. If you just go by the nominal rate printed on [this website](https://www.frbdiscountwindow.org/) it *looks like* the interest rate on these loans is (currently) 5.5%. But you can use prepayments to pay off part of it early, with no penalty, and if you do that, they have to recalculate your remaining interest payments based on the remaining principle of the loan. So you can *massively* reduce the interest rate on your own initiative.

Therefore, I think the BTFP is actually a sneaky reintroduction of Quantitative Easing (i.e. low-interest loans) back into the USA's economy. It may *seem* like interest rates are up in the 5.5% range. But any bank can easily lower that by taking out a BTFP loan and prepaying portions of it early. And they seem to be doing so, because they are the central bank's most popular loan offering.

Unfortunately, due to the enhanced secrecy of these loans, it's hard to tease out which banks use this program, which makes it difficult to figure out if they are using prepayments, which makes it difficult to determine what interest rates are actually charged under these loans. Talk about shadow banking! The BTFP's listed interest rate is not the one banks actually have to pay. Banks can lower their interest payments on their own initiative without explicitly reporting what happened.

So what's the real interest rate for BTFP loans? I just don't know. It probably varies depending on how each bank uses prepayments, and neither the borrowers nor the lender seem to operate under any requirement to report what interest rates anyone actually paid. So I do think it's a form of sneaky QE. Interest rates are lower than they seem -- if you're a bank.

How the Bank Term Funding Program Enables Sneaky Backdoor Quantitative Easing

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