Borrowing at the Discount Window: What Explains Stigma after the 2003 Reforms?

Abstract

In 2003 the Federal Reserve introduced a new Discount Window (DW) regime designed explicitly
to address the “stigma problem” associated with DW borrowing. However, anecdotal and
empirical evidence suggests that the reluctance by banks to access the DW persisted after 2003,
even during the Global Financial Crisis when banks faced serious liquidity shortages. In this
study, we provide the first test of existing theories that attempt to explain the existence of DW
stigma. For identification, we exploit a legally determined rotation policy that assigns federal
and state supervisors to the same bank at exogenously set time intervals. Using proprietary
data from the Federal Reserve, we show that (1) DW borrowing contains information about
future bank underperformance that is not contained in publicly available data, and (2) despite
the information content of DW borrowing, there is no evidence that DW borrowing by a bank
creates an adverse reaction by markets or banking supervisors. Thus, the results show that
neither the market channel nor the supervisory channel explains post-2003 stigma, which implies
that stigma is a legacy of earlier DW regimes. Our findings suggest that the most effective
policy to eliminate stigma would require mandatory DW borrowing by all banks on a regular,
yet random basis.

Keywords: Discount Window, Stigma, Bank Performance, Supervisory Rating, Lender-of-last-resort

JEL Classification: E42, E44, E52, E58, E61, G21