CUNA Comment Letter

Proposed Changes to Discount Window Lending Programs

Via e-mail regs.comments@federalreserve.gov

August 22, 2002

Ms. Jennifer J. Johnson, Secretary
Board of Governors of the Federal Reserve System
20th Street and Constitution Avenue, NW
Washington, D.C. 20551

Re: R-1123 Extensions of Credit by Federal Reserve Banks

Dear Ms. Johnson:

The Credit Union National Association (CUNA) appreciates the opportunity to comment on the proposed amendment to Regulation A that would restructure existing discount window lending programs. CUNA, a national trade association, represents more than 90 percent of the nation's 10,300 state and federal credit unions, and these comments were prepared under the auspices of CUNA’s Payment Systems Subcommittee. In that regard, CUNA supports replacement of the adjustment credit program with the primary credit program, replacement of the extended credit program with the secondary credit program, and retention of the seasonal credit program.

Discussion

The Federal Reserve proposes to restructure its discount window lending programs by replacing two of them and leaving seasonal credit in tact. The Federal Reserve would replace adjustment credit, which has below-market interest rates, with primary credit. Primary credit would have an interest rate that is above the short-term market interest rate, including the federal funds rate. Under the proposal, the primary credit interest rate would initially be set at 100 basis points above the target federal funds rate. Afterwards, Federal Reserve Banks (Reserve Banks) would set the rate, subject to review and determination by the Federal Reserve. Primary credit would be available for depository institutions that are in sound financial condition to use as a short-term back-up source of liquidity. Secondary credit would replace the existing extended credit program. The proposed secondary credit would have an interest rate 50 basis points above the primary credit rate, and it would be available under certain circumstances to depository institutions that do not qualify for primary credit. The proposal currently does not change the seasonal credit program, but the Federal Reserve may adjust the interest rate for the seasonal credit program or eliminate the seasonal credit program altogether based on the comments it receives.

CUNA supports the Federal Reserve’s proposal to introduce primary credit because the adjustment credit program was so restrictive in its requirements that it limited the number of credit unions that could use the program. Under adjustment credit, financial institutions must prove that they need the funds. This requirement leaves financial institutions that use adjustment credit with a stigma and prevents them from using adjustment credit. Elimination of this requirement under primary credit eliminates this stigma and has other benefits. It would reduce the burden of administering the lending program by eliminating the need to verify that borrowers have exhausted other available sources of funds. In addition, primary credit would give the Federal Reserve the ability to set an upper limit on the federal funds rate during a financial crisis by allowing the Federal Reserve to lower the primary discount rate to one that is close to the federal funds rate. CUNA supports setting the initial rate for primary credit at 100 basis points above the federal funds rate because it would encourage most financial institutions to seek credit from other liquidity sources before accessing credit from the Federal Reserve.

CUNA supports replacing the extended credit program with the secondary credit program. The secondary credit program would be necessary because this program expands the class of eligible borrowers to institutions that do not financially qualify for primary credit. As proposed by the Federal Reserve, the secondary credit interest rate would be 50 basis points above the primary credit rate. This higher interest rate is justified because the financial institutions that borrow from the secondary credit program would have lower credit ratings and higher risk profiles. In addition, the type of credit that would be offered justifies the higher interest rate. Credit in the secondary credit program would usually be extended for a longer-term than credit in the primary credit program. The longer extension would make it riskier and should make it more expensive. For all these reasons, CUNA supports the higher interest rate for secondary credit.

CUNA supports the Federal Reserve’s proposal to retain the seasonal credit program because neither primary nor secondary credit would adequately replace that program. Although funding opportunities for smaller depository institutions appear to have expanded due to deposit deregulation and the general development of financial markets, small depository institutions might have to pay higher rates than large depository institutions to attract capital when liquidity is tight. Moreover, both primary credit and secondary credit would have higher interest rates than seasonal credit. According to the Federal Reserve, past precedents suggest that the seasonal credit interest rate would be below the primary credit rate and borrowers under the program would not need to demonstrate that they could not obtain funds elsewhere. The Federal Reserve should retain the program at its historical interest rate, because it fulfills a role that would not be met by the other two lending programs, which would have higher interest rates.

If you have any further questions, please contact CUNA's Senior Vice President and Associate General Counsel Mary Dunn or me at (202) 638-5777.

Sincerely, Michelle Q. Profit Assistant General Counsel