Travis Hill on the Discount Window, Receivership Funding, and Financial Tokenization

Travis Hill is the Vice Chairman of the FDIC Board of Directors, and he joins David on Macro Musings to talk about discount window and bank liquidity, receivership funding, and the tokenization of financial assets. Specifically, David and Travis also discuss the push for pre-positioning at the discount window, how the FDIC funds receiverships, the impact of tokenization on the future of banking, and much more.

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Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Travis, welcome to the show.

Travis Hill: Thanks for having me.

Beckworth: Well, it's great to have you on. You're the vice chair of the FDIC, and you are also a listener of the podcast, I understand. Is that correct?

Hill: That's correct.

Beckworth: Fantastic. It's great to have a senior policymaker who listens to the podcast. So, it's great to have you on and to tell us about the FDIC, what you do there, and some of these issues; the discount window, receivership funding during 2023, very interesting. You had a speech recently that we'll talk about. But tell us first about your journey. How did you get to the FDIC?

Hill: Sure. So, the quick version of the story [is that] after I graduated law school, I got a job working for Regions Bank, which is a regional bank based in Alabama, [and] I had a job in their DC office. Then, in early 2013, I got hired to work for the Senate Banking Committee, where I spent about five and a half years, [and] was heavily involved in a number of legislative efforts, including the Shelby reg reform bill in 2015 and the Crapo economic growth bill that was signed into law in 2018. In the summer of 2018, Jelena McWilliams was sworn in as Chairman of the FDIC.

Hill: She hired me to be her primary policy advisor, so I worked on the staff at the FDIC for close to four years, where I oversaw most of our policymaking and rulemaking efforts. Then, in 2022, I went through the nomination process, got sworn in as FDIC chair in January of 2023. In September of 2024, I was a guest on the Macro Musings podcast, and that's pretty much my story.

Beckworth: Fantastic. So, maybe we should step back and talk about the FDIC. Since this is Macro Musings, we talk a lot about the Federal Reserve [and] other central banks, and the Fed is a bank regulator too, but the FDIC is also a very important one. And probably, for the average person, they know the FDIC probably more than any other bank regulator, but there are others [such as] the Fed, the OCC, there's state bank regulators. How do you guys all relate to each other, and what is the unique role of the FDIC?

The Unique Role of the FDIC and the Vice Chair

Hill: Sure. So, as you mentioned, there's three federal bank regulators and state regulators across the country. The three bank regulators are all bank supervisors and regulators. The supervisory function refers to the bank examiners that we have spread across the country, on-site, at banks that oversee the operations of the bank, ensure safety and soundness. The regulatory function— the three agencies typically work together to issue rulemakings [and] set rules and policies for the entire industry. Then, the key functions that differentiate the FDIC is, first, we're the deposit insurer, which is, of course, why the FDIC was originally created back in 1933.

Hill: Today, bank deposits are insured up to $250,000 per depositor, per bank, per ownership category. That $250,000 number is set by Congress, but the FDIC otherwise sets the rules for deposit insurance, collects assessments to fund the Deposit Insurance Fund, which stands behind the banking industry. Then, the other piece of it is that the FDIC is the resolution authority. When a bank fails, the FDIC does not behave like a typical insurance company where it would pay out the amount that depositors are insured.

Hill: Instead, the FDIC takes control of the bank and, in the vast majority of cases, will sell the failed institution to a healthy institution, because that tends to be both more cost-effective for the FDIC and less disruptive to communities and the broader economy. So, I think those are the two key functions that the FDIC does that the other banking regulators don't do, the insuring of deposits and the resolution authority.

Beckworth: So, when there are changes afoot for bank regulations, how do the three federal bank regulators come together, coordinate, [and] make it happen? So, after the great financial crisis, Dodd-Frank, there's been a series of Basel reforms. How do you guys all get on the same page and make sure that you're saying a similar consistent message?

Hill: Yes, so, most of our rulemakings are joint, so there's an extensive negotiation process that goes on among the three agencies, and often, from the very beginning, when the decision is first made to pursue a rulemaking, one agency, usually, will have the pen. So, they will do the drafting, but the other two agencies will also be heavily involved. There'll be a lot of back-and-forth. Usually, it starts off at the staff level, and then at some point it gets to the principal level where the Comptroller, the Vice Chair of Supervision, and the FDIC Chair will have negotiations. But the process can vary depending on the subject matter and the equities involved from the various agencies. But the majority of high-profile, impactful rules tend to be all three agencies issuing one joint rule.

Beckworth: Okay. Now, what role does the Vice Chair of the FDIC play? What is your day-to-day job?

Hill: So, the day-to-day definitely varies a lot, and I think that It's fair to say that my job and other similar jobs around the government— I think that different people approach it differently. It's not the kind of job where you start day one, and someone hands you a list of assignments to do. So, you're working on behalf of the American people, and what you get out of it is what you put into it. So, I think, in my case, a large chunk of the time is spent trying to deepen my understanding of the issues as much as possible. So, that involves reading things, talking to people, things like that. And so, then, when it comes time for the action part of the job, you're as prepared as possible.

Hill: So, that piece of the job— we have board meetings approximately once per month, although they've been a little bit more frequent lately. At the board meetings, we do a lot of things, but one of the key pieces is voting on rulemakings. And so, as the Vice Chair, part of that is trying to influence the outcomes in constructive ways. Then, another big part of it is, when there are disagreements with what the board is considering, expressing those disagreements, articulating criticisms where appropriate, and trying to inform the public debate. Then, in addition to the board meetings, there's speeches and other public events and other opportunities to do that kind of thing. Then, there's another piece of it, which is trying to brainstorm other ideas on how to do things and highlighting issues that maybe aren't getting attention that I think should.

Beckworth: Yes, and that's reflected in two speeches that we're going to cover today, a speech you did at the AEI and one you did here at Mercatus. They're very thoughtful speeches, looking at issues, thinking through the implications— what does it mean for banking, what does it mean for regulators? We'll come back to that. But as FDIC Vice Chair, just some questions, like in 2023, [which was] very stressful year for you, I imagine [with the] banking turmoil, a lot of stress on the job. So, what do you do to get some rest, get away? What do you do?

Hill: To be totally honest, I'm a pretty low stress person. 

Beckworth: You handle it well then, huh?

Hill: So, I wouldn't say that I really get too stressed about things. I mean, certainly, there are times where unexpected events occur that can put a lot of pressure [on] in terms of decision making and trying to think through things, but I think, from my perspective, when things get busier, I just get busier. I wouldn't say that there's really anything I do to release stress or anything like that.

Beckworth: Alright, you're a natural fit for the job then. That's fantastic. Alright, one last personal question, policy-related too, and that is— I know you're a regular listener of this podcast, probably other podcasts as well. What role do you see podcasts like this one playing in the policymaking process? So, we like to think that there's people listening, and somehow we're informing the conversation. But based on your experience and what you've seen from other policymakers, what role do podcasts play in this process?

Hill: So, speaking personally, I think that podcasts are incredibly useful. I'm a heavy podcast listener, and what I find especially useful about it is that it's a way to be absorbing information while you're doing other things. So, I typically listen to podcasts, sometimes audiobooks too, but when I'm driving in the car, when I am getting ready in the morning, if I'm cooking food, if I'm working out, all things like that. Then, I think that the conversational format makes it easier to multitask, whereas if you're just listening to somebody read something, it requires more focus, whereas if it's conversational, it's a lot easier to still absorb things. So, I think that it's just another avenue to be able to learn things, hear other perspectives, deepen your understanding of issues, things like that. So, I think that it's been a great innovation in the world.

Beckworth: Yes, great to hear. Well, let's jump into your speeches, and the main one that we're going to focus on this morning is the one that you recently gave at the American Enterprise Institute titled, *Reflections on Bank Regulatory and Resolution Issues,* and in that speech, you cover multiple issues. The two that we're going to focus on are discount window and bank liquidity, and the second one [will be] receivership funding, [and], really, lessons learned from the 2023 experience. Let's begin with bank liquidity and the discount window, and as a listener of this show, you know that we've had a lot of conversations with Bill Nelson, Steven Kelly.

Beckworth: I'm someone who thinks a lot about the size of the Fed's balance sheet and the potential implications from the use of the discount window, and in particular, this big push recently for pre-positioning at the discount window, make it count towards some liquidity requirements. So, I'm interested to hear, first off, your perspective on this whole big push. Why has it happened, and where are we in this process?

The Push for Pre-Positioning at the Discount Window

Hill: Sure. Well, as you know, people have been talking about discount window issues for a long time, but it really came back into the forefront after the SVB and Signature failures last year. To start, when SVB failed, people looked at SVB and saw a bank that had more than half of its assets in Treasury and agency securities, suffered this huge deposit run, and, basically, was unable to borrow from the discount window in any meaningful way. So, that immediately raised the question of, why couldn't they just have pledged all of these securities to the Federal Reserve?

Hill: Then, over the next few weeks, there were stories and reports that came out that detailed how both SVB and Signature had these frantic efforts, in their last hours, trying to get collateral to the discount window with varying degrees of success. The other piece that, I think, has gotten a lot of attention is the speed of the run. After the 2008 crisis, the regulators around the world agreed to this liquidity coverage ratio, the LCR, which is the primary standardized liquidity rule for large banks, and that rule essentially requires banks to have large stockpiles of liquid assets that they can monetize over the course of a theoretical 30-day deposit outflow.

Hill: In this case, if you're going to have a massive deposit run over the course of a few hours, being able to monetize securities through any means other than the central bank is just not realistic. And so, if you're going to have that type of speed of [a] run, the only place that you're really going to be able to go is the central bank— either the discount window or reserves at the Fed. So, in terms of how to respond to that, there's a couple of closely related objectives. One is, how do we ensure that banks are prepared to use the discount window and that the discount window is usable? Then, a second is, can we make banks more resilient to these types of runs?

Hill: And so, that's what all led to this concept of a discount window pre-positioning rule, which is a derivation of a proposal from Mervyn King about a decade ago following the 2008 crisis— this “pawnbroker for all seasons” idea. And that was a purer and more extreme version of what's under consideration now, where what he was proposing would get rid of all of the capital and liquidity rules, and it would impose just a 10% leverage ratio and this requirement that a bank's cash plus capacity to borrow at the central bank would exceed all of its short-term liabilities.

Hill: And so, the idea there is that, in effect, to achieve a similar objective to deposit insurance, where you're trying to solve the run risk problem by removing the risk of loss and getting as close as possible to ensuring that the bank will be able to cover whatever outflows there are— The problem with that, at least in the United States, is that if we impose that type of rule across the board, [then] we would, at a minimum, radically reshape how we do banking in America and potentially crater the economy in the process.

Hill: And so, I think that, in recognition of that, what people have been considering is a more modest version of that, where the denominator would be a subset of your liabilities, specifically uninsured deposits, and the required ratio would be something significantly less than 100%, which has some merits in theory. But the problem with that is that if you impose that type of rule, you're basically announcing to the world that the banks are not going to be able to cover all of their uninsured deposits, which maybe is fine today, but if you're ever in a panic-type situation, like the SVB situation— if the SVB depositors all look and say, "Oh, they have a 40% coverage ratio. That means that we better make sure that we're in that 40%, and we get out before they run out of capacity." And so, that's essentially the point that I was making in the speech.

Beckworth: Yes, so, it was interesting to read that. This first mover problem really isn't solved, and maybe even exacerbated, if only a certain percent of the uninsured deposits are covered. What's also interesting about this is that Mervyn King's proposal for “pawnbroker for all seasons” is kind of a corner solution. This is something that Steven Kelly highlighted on a previous show, that you go all over, just completely to liquidity regulations as the solution. And I've had another guest on this show, Anat Admati, and she's at the other corner solution. She wants it all capital funded. 

Beckworth: The real-world is somewhere in between, in the middle. And what you're saying, what others have said, is that we're just pushing that point just a little bit. We're nudging it closer to Mervyn King's idea, but it may not be sufficient and possibly could worsen things, because you're not covering all of the uninsured deposits. So, it's interesting to frame this in terms of something else you've said, that you can view these two things as trade-offs here. How much do we use in the discount window versus deposit insurance? And we're tweaking at the margins here in terms of costs.

Hill: Yes, so, it's interesting to compare the expanded use of the discount window to expanding deposit insurance. And I think that there are misperceptions sometimes that expanding deposit insurance is more expensive than expanding use of the discount window and that expanding deposit insurance increases moral hazard and expanding the discount window doesn't. Whereas, I think that it's more complicated than that. And so, if you think about just the cost to the FDIC— So, if we take a very simple example and just imagine a bank that has, say, $100 in uninsured deposits, and we assume that that bank ultimately is going to fail, if the FDIC came in and insured that $100 of deposits in scenario one—

Hill: In scenario two, we let that $100 in uninsured deposits run out the door and the bank replaces it all with discount window borrowing. In both cases, the bank subsequently fails. In that case, the discount window borrowing is almost always going to be more expensive to the FDIC, because the FDIC is going to pay out the Fed 100 cents on the dollar right off the bat, whereas if the deposits are insured, the FDIC typically will sell that institution along with all of the insured deposits. Those insured deposits have franchise value.

Hill: And so, in effect, the amount that the FDIC is going to be paying on those deposits, when you think about the cost of the transaction, is going to be something well less than 100 cents on the dollar. And so, it's a little bit more complicated than that, because you're making a bunch of different assumptions. But I think that the notion that, to the FDIC, it's more costly to insure deposits, I think, is not really right. It is true that, based on the way we currently do our assessments, that if you expand deposit insurance, banks will have to pay more in order to achieve the same reserve ratio, whereas if you expand use of the discount window, that's not the case.

Hill: But that's really just a policy choice on how we fund the Deposit Insurance Fund, not really a reflection of what the ultimate costs are. And just on the moral hazard piece, just real quick, to me, it's like the run risk and the moral hazard are direct opposite problems. If you want to solve the run risk problem, you create moral hazard, because the way you solve the run risk problem is that you take away the risk of loss. If you want people to have risk of loss, then you solve the moral hazard problem, but then you have the run risk problem. So whether you're using deposit insurance or you're using the discount window, if the objective is that we want to reduce or remove the risk of loss, then you're going to have the moral hazard problem either way.

Beckworth: So, there's a tension there no matter which approach you take, but in the case of the discount window, it's something that, probably, advocates of it, myself, when I champion it on the show sometimes— I need to wrestle [with it] more closely. If there is a cost to parking everything at the discount window, there is no free lunch for taxpayers here.

Hill: Right, or at least for the funders of the deposit insurance.

Beckworth: Funders of the deposit insurance, okay.

Hill: And again, I'm not saying that that's a reason not to use the discount window. We just shouldn't assume that it's a costless option.

Beckworth: Okay, but let's take for the sake of argument that the proposed steps-- Has it been implemented?

Hill: No. So, this is still all under consideration. Nothing has been proposed yet.

Beckworth: So, it's still in the works. Let's say that it comes into rulemaking and it's passed. So, 40% of the uninsured deposits are covered at the discount window with pre-positioned collateral. You note in your speech that there's an inconsistency in how this is being applied and that we want to encourage more use of the discount window, but at the same time, some of the liquidity requirements won't accept the collateral at the discount window. So, maybe talk about that and how you would resolve it.

Addressing the Current Issues Relating to the Discount Window

Hill: Right, so, I think that the main liquidity rule is the LCR. You don't get credit in the LCR for capacity at the discount window. I personally think that it is worth considering amending the LCR to allow capacity at the discount window to count for the high-quality liquid asset piece of it. Because, ultimately, we talked a little bit earlier about this idea that the LCR envisions monetizing securities over the course of this 30-day period.

Hill: As the resolution authority for SVB, and Signature, and First Republic, one of the things that we learned, or that was reinforced for us, is this notion that, even in a 30-day period, being able to sell that volume of securities is not realistic without having a major impact on markets and on other banks that own securities in those markets. So, I think that having the discount window as some piece of the solution for the deposit run problem makes sense, and rather than creating all of these different rules for each potential scenario, I think that it makes more sense to just have one primary liquidity rule that envisions a bank having multiple options, given that we're not going to know exactly how this is going to unfold.

Beckworth: So, part of the goal here is also to lessen, maybe even eliminate the stigma of the discount window. So, even if we're just covering 40% of the uninsured deposits, isn't the hope that, in the event of a crisis, banks will be so familiar— they will be so comfortable using the discount window. Even if they're not fully covered, they can still go there. That's part of the story, too, correct?

Hill: I think so, yes. The discount window stigma is a hard problem to solve. It's a problem that people have been trying to solve for a long time. I think that regulators conveying to the public and to the industry that the discount window is something that they are comfortable with banks using is a helpful step in trying to reduce the stigma and improve the usability. But I think that probably is only a small part of the story.

Hill: I think, at the most fundamental level, as long as the discount window is something that banks don't use in the normal course, and it's something that the markets can identify when banks are using it, there's always going to be a stigma problem, because the markets will assume, once they know the bank is using it, it means that the bank is in trouble and doesn't have access to other funding. So, I know that there are people who have tried to come up with different types of creative solutions for that problem. At its most fundamental level, I think that it will be hard to solve that problem unless either it's not public and the public doesn't know about it, or banks use it more frequently and not only in the case of emergency.

Beckworth: Yes, so, Steven Kelly— to mention him again— he has a proposal that the Fed should further disaggregate what it reports on its balance sheet, so that you can't back out which Fed district is having lots of funds being lent out to banks via the discount window. Another proposal, speaking of the other possibilities suggested here, is Bill Nelson— he may not be the only one, but he's the one that I know about, where he would reintroduce the Term Auction Facility. So, the Fed would auction out funds, I guess, via the discount window, but there would also be these collateralized lines of credit. So, it would be kind of like an enhanced version, I guess, of pre-positioning.

Beckworth: Actual lines of credit, the Term Auction Facility, and between the two, it would become a regular thing, a standard operating procedure. My question is this, would that work? Would that be enough? Maybe, a follow-up question is, should we be careful? Maybe we want some stigma. Again, there are trade-offs. If you take the stigma too far down, [and] you eliminate it altogether, then moral hazard and other problems arise. So, I guess, again, first question is, do we think that would work, and secondly, should we be careful if it does work?

Hill: Yes, I think that's exactly the right question to ask, and that's the fundamental trade-off. The Fed could easily solve the stigma problem if it turns the discount window or some alternative to the discount window— if it lowers the price, improves the functioning, starts to market it as if it's a player in the market. If you take the rate down low enough, and you do enough of those things, eventually it's going to be used more widely, but I think that it's a very fair question. Would we really want a central bank that is playing that kind of role in the economy? And I think the answer to that is probably not.

Beckworth: Correct.

Hill: So, the question is, how do we figure out a way where banks use this more often than just in an emergency, but not so often that it's becoming a major player in the market. I don't have a good answer for that, but I think that that's the fundamental trade-off, and I think the idea that Bill Nelson has been proposing is a very interesting one that potentially could work, but I'm not enough of an expert on the details of it to be able to give a definitive answer.

Beckworth: Well, I've heard that there's a number of challenges with it, starting with the Federal Home Loan Banks, because they offer better terms than the Fed could ever offer— the terming of it, rates, all of those things. Another question I have, and we'll move on from the discount window, but you also mentioned, in your speech— and this was really fascinating— in the footnote, you highlight this, is just the technical issues with the discount window. So, assuming that we do all of these things, we've got to make sure that the discount window is up to modern standards. So, you mentioned in the footnote, and maybe you're quoting from someone else, but you mentioned that someone who wants to use a discount window, they have to make a phone call— literally pick up a phone and call someone, whereas [with] the Federal Home Loan Bank loan, you just get on the computer, you type in a few keys and boom, it happens. So, are we seeing progress made on the discount window?

Hill: So, I believe that the Federal Reserve has very recently put in place a portal where banks can go to request discount window funding, but it's still, for my recollection, on a fairly limited basis. But I know that, more broadly, there is an effort underway at the Federal Reserve to try and modernize some of the discount window process. I think, to some extent, it goes back to what we were talking about earlier, whereas to what extent is this a feature or a bug?

Beckworth: Great point. 

Hill: Because I think, to some extent, there are people within the Federal Reserve System that want there to be frictions in place in order for banks to borrow. But I think that the SVB example has woken people up to the fact that being able to borrow from the discount window, under an extremely short time horizon, is important.

Beckworth: Yes, and so, I guess where I would land would be that there's a pendulum between moral hazard getting too excessive and then not being flexible and resilient enough in times of crisis. And maybe we're a little too close to that point where we're not resilient enough. We can maybe push the needle back just a little bit and make ourselves more flexible and able to handle things better at the discount window. Alright, so, that's a big part of your speech, but probably, an even more interesting part of your speech was on the FDIC and how it funded the 2023 receivership of SVB and Signature. And as you note in your speech, it was with Fed borrowings. You also note in your speech that the FDIC did not pay these loans off for another nine months, and this was unprecedented, and you want to think about this. So, let's come back to that point, and maybe just lay some groundwork here for us. This was new to me since I'm not an FDIC guy, but walk us through the various ways that the FDIC can fund itself when it does take over these failed banks.

How Does the FDIC Fund Receiverships?

Hill: Sure. So, typically, when a bank fails, the receiverships are funded with the Deposit Insurance Fund. That's why the Deposit Insurance Fund exists. The banks all pay assessments into it. There's a sizable portfolio there to give the FDIC the wherewithal to be able to fund receiverships. In this case, the immediate cash needs, when SVB and Signature failed, were extremely large and larger than the amount of funds that were in the DIF. And I should emphasize here, that this is solely a liquidity issue, because the FDIC also assumed all of the assets from the failed bank. But as we talked about earlier, the FDIC was not able to go out and sell all of those portfolios in any sort of rapid time period.

Hill: So, number one, no matter what, the FDIC would have needed to access other funding in addition to the DIF. There were other reasons why the FDIC chose not to use the DIF, at least in its entirety. The FDIC ended up using about $50 billion from the DIF, which was about 40% of the total funds. But then, as you note, most of the funding came from Federal Reserve borrowings. The other option, that is the most obvious option, would be to borrow from either the Treasury Department or the FFB, the Federal Financing Bank, and the FFB is the preferred solution for borrowing from the Treasury.

Hill: And the FDIC has statutory authority to borrow from the FFB and Treasury, and that borrowing would have been at a market rate. What made the Federal Reserve borrowings particularly costly was that the Federal Reserve charged a 100-basis point penalty rate on top of the normal Fed discount window rate. And so, as you noted, it took about nine months for the FDIC to pay off those borrowings. And so, that ended up being a very costly series of decisions. The penalty rate alone cost the FDIC about $1 billion, and that's only just comparing it to if we had had the same borrowings outstanding but were at a market rate either from the Fed or from Treasury, which almost certainly understates the overall cost, because the FDIC almost certainly could have paid off those borrowings a lot sooner.

Beckworth: So, why did the Fed charge that extra penalty rate? Because this was the FDIC. You're backed up by the US government. What's the risk? Why the penalty?

Hill: Right. So, that is an argument that the FDIC made very strongly to the Federal Reserve, and I think that it is worth considering, whether it's appropriate for the Federal Reserve to charge a penalty rate in this type of scenario. When SVB and Signature Bridge Banks opened, they both borrowed heavily from the Federal Reserve. When the bridge banks were closed, the Federal Reserve viewed that as a default, and under the Federal Reserve Circular, once a loan is defaulted, they charge a 500-basis point penalty rate. The FDIC and the Federal Reserve negotiated and ultimately agreed on a 100-basis point penalty rate. I tend to agree--

Beckworth: So, they were being gracious with the 100 basis points?

Hill: Well, I think that's a matter of perspective. I tend to agree with you that I think that, given that these borrowings were backed up by the full faith and credit of the US government, and given the situation at the time, in effect, this was a transfer from the Deposit Insurance Fund, primarily through the special assessment, to the Federal Reserve, which ultimately, in the long run, remits its earnings to Treasury.

Beckworth: And the Deposit Insurance Fund, the DIF, is ultimately funded by the banks, right?

Hill: Correct.

Beckworth: So, maybe I can be cynical here. I know you can't say this, but I'll say this. So, the banks paid that extra fee to the Fed, and maybe the Fed was happy to get that, because they were losing money at the time. And so, I know that you can't comment on that, but I'll put the cynical comment out there. Maybe the Fed was pleased to get a little extra income as it's bleeding on its own balance sheet. Okay, but let's go back to the sources of funding. So, we have the Deposit Insurance Fund— and it was just really interesting to learn some of the details. 

Beckworth: So, you have to invest in nonmarketable Treasury securities, which then kind of puts you at the mercy of the Treasury when you want to liquidate and fund the receivership. So, that made it challenging, particularly in this case because there was a debt ceiling debate going on. Now, you argue that they could have pushed, they could have asked for more, but you suggest, maybe as an alternative, to have some of those funds at the Fed so that we can quickly get them in times of an emergency. Any more thoughts on that and having funds at the Fed?

Hill: Yes, so, look, I suspect that every government agency, if given the choice, would like to be able to put its funds at the Fed, especially if the Fed was willing to pay interest on the reserves. But I think that the FDIC is in a particularly unique situation where I don't think that there is any other government agency that faces the same potential for very, very large and completely unexpected cash needs. And so, if you think about how the Treasury manages the debt ceiling once it gets close or once it passes the limit, the potential that the FDIC could need hundreds of billions of dollars to fund receiverships— that is a very difficult thing for the Treasury Department to plan for.

Hill: There are other options that I touched on in the speech. For example, I think that the FDIC and Treasury could have come up with some sort of plan where the FDIC redeems its securities, and Treasury issues new securities on the same day, something like that, because once the FDIC redeems its securities, that creates more headroom under the cap. So, there are ways that this could have been navigated, but I also think that it would have been much cleaner if the FDIC was able to just have funds at the Fed and then didn't have to deal with the possibility that its funds might be difficult to access.

Beckworth: And I can see why the Fed might be supportive of this idea, because what you're doing is supporting financial stability. That's one of the mandates for the Fed. So, if they allowed you to have your own version of a TGA at the Fed, you could have the case made that this is for financial stability purposes. Alright, so, we've talked about the DIF, the Treasury. Then, you already touched on this, but the Federal Financing Bank. Again, this was new to me, but this is very interesting. They're kind of a bank for all of the federal agencies, and they're the institution through which the FDIC could sell assets, securitize assets, so talk about that institution a little bit.

Breaking Down the Federal Financing Bank

Hill: Yes, so, the FFB is essentially a part of Treasury. I don't know if they're technically a part of Treasury or just affiliated with it, but it primarily exists for government agencies to borrow from the Treasury and other similar functions. And the Treasury Department's preference is for the FDIC to borrow from the FFB rather than from Treasury. And so, the FDIC did borrow from the FFB back in the early 1990s when the Deposit Insurance Fund had gone negative.

Hill: Back then, there was, to my knowledge, no negative market reaction or anything like that, and it took a couple years for the FDIC to pay that back. In the 2008 crisis, the FFB was considered as an option, but ultimately, the FDIC instead decided to require the industry to do a prepayment of assessments, which was, in effect, sort of like borrowing from the industry. In this case, obviously, the decision was made not to borrow from the FFB. Ultimately, the FDIC did monetize some assets through the FFB, which is, in effect, sort of like— the FDIC sells, essentially, the future cash flows of securities that the FDIC maintains ownership of, and the FFB provides the funding up front to the FDIC.

Hill: And so, for example, with certain types of securities that were illiquid, that don't really trade, that was an alternative to the FDIC just holding on to those securities or trying to sell them at a steep discount. And these are fully guaranteed securities. These were Ginnie Mae securities. But one could imagine a future scenario where, if other alternatives, for whatever reason, are unavailable or difficult, the FDIC theoretically could monetize a large stockpile of securities through the FFB, and, I think, in an ideal world, do it over resolution weekend so that you've got all of that funding right up front. But that's just another potential alternative that hadn't really been explored prior to 2023.

Beckworth: And as you mentioned earlier, this is part of your job. Think through the possibilities for future crises, lessons learned, and moving forward with them. In your speech, you seem to articulate some sense of a stigma associated with using the DIF--

Hill: The Treasury.

Beckworth: -The Treasury, yes. There's this reluctance there, and therefore, it wasn't fully tapped. I mean, you said $52 billion was taken out?

Hill: Yes, so, about $52 billion was taken out from the DIF. There was about $120 billion or maybe $125 billion right before SVB failed. So, I guess, maybe there's two things. There's the DIF and Treasury. With the DIF, I think that there was some concern that if we draw down the DIF too far and additional banks fail, that could influence depositor confidence on whether or not the FDIC would be able to make good on its insurance commitments. I tend to think that that, probably, is overstated, and I also think that there's a little bit of an inconsistency of, we're going to use these other options rather than the DIF, to ensure the funds in the DIF are still there. But then, if additional banks fail, are we not going to use the funds in the DIF, because we want to make sure--?

Beckworth: Exactly, the irony is rich.

Hill: Yes, so, my overall takeaway is that, in the immediate days following SVB and Signature failing, I think that there's probably some merit in being cautious and not wanting to just immediately take the DIF down to zero. But I think that over the course of the weeks and months that followed, as things were settling down, we would have been very safe to have taken that further down, and especially, once we got to the summer, after First Republic failed, after the debt ceiling was resolved, I don't really think that there was that much turmoil still present in the market. And so, whereas we didn't finally pay off the Federal Reserve borrowings until the end of November, I think, at a minimum, by July or August, we could have paid that all off.

Discount Window Stigma and Uncollateralized Fed Funding

Beckworth: So, I bring up the stigma idea because Steven Kelly had a recent blog post where he responded to your speech. I think you saw it. And he had this to say. First, he mentioned that there was a similar hesitancy in 2009 because of all of the bailout fatigue. So, DIF didn't go to Treasury because they were reluctant to be seen as adding to the bailout mentality or overuse of it, but he had this to say, and I want to get your response to it.

Beckworth: He says, "Certainly, to the extent there is due or undue reticence toward accessing both the standing DIF funds and the FDIC's backup credit lines, and to the extent the debt ceiling binds, the FDIC may feel its hands are tied. Thus, the Fed's discount window and other lending facilities may, in a twist of irony, represent the least stigmatized option for the FDIC to preserve its liquidity in future crises." So, we started with a discount window stigma discussion. Here we are back at it. What are your thoughts?

Hill: Right, the opposite, whereas the discount window is stigmatized for the banks but less stigmatized for the FDIC. I think that's a fair observation of what happened in 2023. As I said before, I think the concerns that the FDIC has around the stigma of using the DIF and using funds from the Treasury is probably overstated.

Beckworth: So, one last question on this receivership funding question from the 2023 experience, and this is another point that Steven Kelly has made. He observes that a second unprecedented part of this experience is that some of the funding from the Fed was uncollateralized. So, how do you respond to that?

Hill: Maybe I'll distinguish First Republic versus Signature. So, in the case of First Republic, as Steven Kelly pointed out in his paper— So, First Republic borrowed extensively from the discount window pre-failure. So, when First Republic failed, the FDIC, in effect, took the collateral that had been pledged to the Fed and replaced it with an FDIC guarantee. I think, in that case, it's interesting to think through the options there. So, one option there is that the FDIC, theoretically, could just let the Federal Reserve Bank foreclose on the collateral and wash its hands of it. That is not how it works today, and to my knowledge, that has never happened. The way it works is that the FDIC has an agreement with the Fed where the FDIC will pay off the Fed and the FDIC takes the collateral. 

Hill: I personally think that, in certain situations, it may be worth considering whether the FDIC should just let the Fed foreclose on the collateral. But if that is not an option, then I think that the FDIC needs to have the ability to replace the collateral with a guarantee, because otherwise, it is possible that the FDIC may not be able to pay off some portion of that, because, in effect, think about [it] theoretically. If you had a bank that had $200 billion at the discount window and had, say, $250 billion of collateral pledged— If the FDIC could not access that $250 billion of collateral until it pays off all of the discount window borrowings, that potentially just constricts the FDIC's options in ways that are probably not cost-effective or helpful.

Hill: The Signature case is a little bit different, because that was a case where the bridge bank itself was borrowing, at least to some extent, on an under-collateralized basis, where the FDIC was providing a guarantee to serve as the collateral. I think it is worth noting that— And Steven Kelly talks about this a little bit in his article, too. The FDIC has a statutory limit on how much it can borrow. That limit applies both to the FDIC's borrowing from the FFB, and it also would apply to guarantees that the FDIC provides for uncollateralized borrowing. Steven Kelly points out that there may be arguments to be made on how the FDIC should consider those types of guarantees when it calculates it, but I think, at a fundamental level, it's not the case that the FDIC has an unlimited capacity to guarantee borrowings from the Fed, but yet, has limits from Treasury.

Beckworth: Okay, well, let's move on to another speech that you had. Back in March, you gave a speech that was titled, *Banking's Next Chapter? Remarks on Tokenization and Other Issues.* I want to read just the first paragraph and a half from your speech here. “Money and payments have been evolving for as long as they have existed. From general commodities, to precious metals, to cash, to credit cards, the methods that society has used to store and transfer value has changed dramatically over time, and each major upgrade to the monetary architecture has introduced both new benefits and new risks. Similarly, our payment clearing and settlements infrastructure, the plumbing at the heart of the financial system, has evolved considerably over the past several decades. Against this backdrop, I am going to focus on one specific innovation that has been the subject of a tremendous amount of research and development in recent years, tokenizing commercial bank deposits and other assets and liabilities.” So, let me begin with this. What is tokenization?

Tokenization and Its Impact on the Future of Banking and Cross-Border Payments

Hill: Tokenization generally refers to the use of distributed ledger technology to put real-world assets and liabilities on common platforms that unlock a series of functions and capabilities that don't really exist today. So, for the past couple of decades, there's been a lot of attention on real-time payments. Tokenization is the next level beyond that, where it does enable real-time payments and settlement but also enables a variety of other functions by bringing various parties and processes all to one common platform, and on that platform, you can do things like have smart contracts, where you can hardwire, into the platform, future actions that are conditioned on real-world events. You can also do things like tokenize certain types of assets that then can be used in various other ways that they cannot be used now. 

Hill: So, for example, one thing that you can do is, say, tokenize an interest in shares of a money market fund, and then, if an owner of a money market fund needs to, say, post collateral for some other purpose, rather than needing to liquidate their share in the money market fund, and then get cash, and then post the cash as collateral, which involves multiple processes and parties— instead, the entity can just take that token and post the token as collateral, and you've cut out multiple steps and intermediaries. And so, as I noted in the speech, there's a ton of work, research, [and] experimentation going on in trying to experiment with lots of different use cases for if we move to this type of environment.

Beckworth: So, wow would tokenization affect the structure of banking in the future?

Hill: So, I think it potentially could be revolutionary to how a lot of banking is done. As I said, part of it is moving everything to real-time settlement. It will unlock, as I sort of said, a lot of additional functions, a lot of additional capabilities. It will also just make a lot of things more efficient, because it will cut out different steps in the process, different intermediaries. I think that there's still a lot of uncertainty as to how this will evolve and whether, for example, there will be a small number of platforms that all of the banking industry and other actors in the economy are somehow plugging into, or whether there would be more of a diversity of platforms across the board. I think that these are the types of questions that will take some time to answer. And obviously, as I said, there's a lot of uncertainty in how this will all evolve, but it has the potential to be revolutionary.

Beckworth: Okay, so, one area that's been brought up often, in the case of the U.S., is cross-border payments not being very efficient, very expensive. And I often hear people make the case that we need wholesale CBDCs to increase the efficiency of cross-border payments. But could this be another approach to make it easier to do cross-border payments?

Hill: Yes, for sure. And one of the use cases that has gotten some attention that is related to that is that if you think about a corporation that exists in multiple jurisdictions around the world— today, they need to basically make forecasts on what their funding needs will be in each of the different jurisdictions and have sufficient funds, in how they manage their Treasury operations, to ensure that they can meet those needs. If, someday, we move into this tokenized world, or even if we just partly move into the tokenized world, it's possible that what those corporations can do— not only can they move funds across borders on a much faster basis, but they can have smart contracts that have triggers built in that say, "If these triggers are hit, we will have funds automatically move into this jurisdiction." And so, that reduces the need to have these buffers and forecasts that you're using for your Treasury management.

Beckworth: Very interesting. It strikes me that this could be another way to enhance dollar dominance around the world if these tokens are used widely and they're very popular, and, ultimately, there's dollars backed behind them somewhere. It would just enhance the use of the global dollar network, which, from a U.S. government perspective, is very important.

Hill: Yes, so, I think that that's an interesting point, and it probably, in some respects, could cut both ways. So, I think that some of the U.S. banks are very heavily involved in doing research on this and developing some of these capabilities and products. But from the public sector standpoint, I think that the U.S. has been a lot further behind on this. And so, there are other jurisdictions around the world, like Singapore, for instance, certain jurisdictions in Europe, that have been much more open-minded and forward-leaning on some of this stuff.

Hill: And so, I do think that there is some risk that if the U.S., from a public sector standpoint, continues to be slower in its understanding and open-mindedness that as these platforms and capabilities are being developed, that the standards and public expectations are going to be developed overseas before we catch up. I don't think that there's really that much risk in dollar dominance being threatened by this, because, at the end of the day, the U.S. banks are still heavily involved in all of this, and there's a lot of other factors that I think are probably more important that contribute to the dollar as the reserve currency. But I also think that there is a real risk that if the U.S. continues to be behind the ball on this, that things that we care about could be left out as all of this stuff gets developed.

Beckworth: Yes, for sure it would be, maybe, an improvement on the margin for dollar dominance. But like Randy Quarles said in his speech, stablecoins could actually enhance the spread and use of the dollar. But just to be clear, in what manner are we falling behind? Is it because the U.S. government is currently taking a critical view to the crypto space, to tokenization space, to private sector engagement in this? Is that the issue?

Hill: So, I think it's more that, in certain other jurisdictions, the public sector is forward-leaning in trying to encourage experimentation and, in some respects, participating in some of that. In the U.S., we have a little bit of that with the New York Fed participating in the regulated liability network. But overall, the banking agencies, at least, have been, I would say, more of a hurdle rather than a participant.

Hill: And so, again, it's not that the banking agencies are preventing the banks from doing things. It's that there are lots of hurdles and obstacles and impediments that are being put up as the banks are proceeding. And just to be clear, I do think that it is important, as the bank regulators, that we are understanding what the banks are doing, and I think that it's warranted to have at least some degree of caution.

Hill: But I also think that, right now, we are probably too far in the spirit of skepticism around new things in ways that is making it more challenging for banks to move forward on things, whereas I think what we can and should be doing is trying to develop our expertise and understanding as quickly as possible so that we can enable more of this to go forward and be more clear and upfront about, “Here's what our expectations are,” in order for banks to do things in a safe and sound way, rather than this constant, “We need to understand this better, we need to understand this better,” kind of thing.

Beckworth: Well, this will be an interesting development that we will follow. Maybe, in the future, we will have you back on to give us an update on tokenization and the banks. Well, with that, our time is up. Our guest today has been Travis Hill. Travis, thank you so much for coming on the program.

Hill: It was great to be here. Thanks for having me.