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Fed Pulls Plug on Funding Lifeline, Ripples Through Crypto Markets

Last Updated January 25, 2024 11:48 AM
Teuta Franjkovic
Last Updated January 25, 2024 11:48 AM

Key Takeaways

  • The Federal Reserve will close the Bank Term Funding Program (BTFP) soon.
  • The Fed plans to increase the interest rate on new loans under the BTFP.
  • The closure of the BTFP and the increase in the interest rate are likely to impact the crypto markets negatively.

The Federal Reserve announced  the planned closure in March of a funding lifeline established for banks in the aftermath of Silicon Valley Bank’s collapse, which had posed a threat to the broader financial stability last year.

The announcement will also see an increase in the interest rate on new loans under the Bank Term Funding Program (BTFP) effective immediately.

Fed to Close Emergency Banking Program as Stability Returns

The Federal Reserve announced  the closure of the Bank Term Funding Program (BTFP) on March 11, signaling a recovery from the banking sector crisis triggered by the collapse of Silicon Valley Bank (SVB).

This program, described  by Michael Barr, the Fed’s vice chair for supervision, as a response to the emergency caused by SVB’s downfall, was a key intervention during a time of extraordinary market turmoil and deposit runs, which also affected the SVB and Signature Bank .

Barr stated :

“It was designed for that emergency to say, We want to make sure that banks and creditors of banks and depositors (in) banks understand that banks have the liquidity they need.”

The termination of the BTFP, alongside an increase in interest rates for new loans, marks the end of a crucial support phase for U.S. banks. This development is significant not just for traditional banking but also for the crypto industry, which experienced heightened uncertainty  during the SVB collapse.

What This Means For Crypto?

The Fed’s move is likely to tighten the liquidity in banks, leading to a slowdown of lending activities. This could make it more difficult for crypto companies to obtain loans from traditional banks, which could impact the growth of the crypto industry.

Ex-CEO of cryptocurrency exchange Bitmex, Arthur Hayes, highlighted  the Federal Reserve’s decision to discontinue the Bank Term Funding Program (BTFP). He theorized  that banks holding U.S. Treasuries (UST) or Mortgage-Backed Securities (MBS) with “hold-to-maturity” (HTM) losses should consider exchanging them for new funds by March 11th, thereby gaining an additional year.

However, Hayes pointed out a dilemma : if the Federal Reserve reduces or terminates its Quantitative Tightening (QT) program, causing bond values to increase sharply, then banks that have already locked in less favorable funding would be at a disadvantage.

The Fed raising the interest rate on new loans from the BTFP could also lead to some banks pulling back from lending to crypto companies altogether, as they will be less likely to be able to profit from the arbitrage opportunity.

Overall, the Fed’s decision to close the BTFP and raise its interest rate could likely harm crypto markets and make it more difficult for crypto companies to obtain loans, which could slow down the growth of the industry.

There are three possible ways in which the Fed’s decision could impact the crypto market:

  1. Crypto Lending and Borrowing Trends: The crypto industry has seen emerging trends in lending and borrowing, with platforms offering a variety of crypto loans, including against cryptocurrencies as collateral. This indicates a growing integration of crypto assets with traditional financial mechanisms.
  2. Regulatory Environment: The regulatory landscape for crypto-friendly banks and crypto services offered by traditional banks is evolving. This could mean that any changes in traditional banking policies, like those from the Federal Reserve, could indirectly affect crypto companies, especially those reliant on traditional banking services for operational or lending purposes.
  3. Impact on Crypto Market Dynamics: Changes in traditional financial policies can influence the broader financial market, which in turn may affect the crypto market. For instance, higher interest rates on traditional loans could make crypto-based lending more attractive or vice versa, depending on the comparative rates and risks​.

US Financial Regulators Express Concern Over Crypto Sector

Last year, the Fed, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency – issued a joint statement  highlighting their significant concerns about the risks associated with the crypto sector. The statement pointed out the dangers of business models heavily concentrated in or exposed to crypto-asset-related activities, signaling a cautious stance towards the integration of crypto assets in the traditional financial system.

The American crypto sector faced heightened challenges in March of the previous year when three major financiers to the industry, Silvergate Capital , aforementioned Silicon Valley Bank, and Signature Bank , collapsed in quick succession.

This series of bank failures left numerous U.S. crypto firms without a domestic banking partner, exacerbating the industry’s challenges. Further complicating matters, the reluctance of other American banks to onboard these firms, considering the perceived risk, forced some U.S. crypto businesses to seek banking partnerships abroad.

Narrowing Arbitrage Window

Effective immediately, the Federal Reserve has announced  a significant change in the interest rate for new loans under the Bank Term Funding Program (BTFP). The new rate will be no lower than the interest rate on reserve balances on the day of the loan, resulting in an approximate 50-basis-point increase in borrowing costs. As of Tuesday, the BTFP loan rate stood at 4.93%, compared to the current 5.40% yield on reserve balances.

The previously favorable terms of the BTFP had contributed to its growing usage, with a steady increase despite a lack of apparent market distress. According to recent Federal Reserve data, loans outstanding  as of January 17 amounted to $161.5 billion, with an average weekly increase of nearly $5.6 billion over the last six weeks – the highest since early May.

However, this also created an opportunity for banks to borrow from the BTFP at lower rates and redeposit the funds with the Fed, thereby earning a higher interest rate on reserve balances. The Fed’s decision to increase the BTFP loan rate aims to close this arbitrage gap and reflects a shift in its approach to managing lending under the program.

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