Bowman identifies weaknesses in bank liquidity framework, calls for reform
Federal Reserve Vice Chair Michelle W Bowman highlighted shortcomings in the current bank liquidity framework, arguing it fails to ensure true resilience. Speaking in Washington DC on March 3, 2026, she called for fundamental reform of the discount window and regulatory requirements.
Liquidity rules create hoarding, not resilience
The prudential liquidity framework, largely developed after the 2008 financial crisis, relies on the Liquidity Coverage Ratio (LCR), Net Stable Funding Ratio (NSFR), internal liquidity stress testing, and resolution planning.
While designed to ensure resilience, Bowman argues these tools may not capture real-world vulnerabilities.
She questions if compliance truly translates into resilience, noting the LCR's failure to credit collateral pledged for Federal Home Loan Bank advances.
This framework creates two problems: during normal times, banks over-allocate to high-quality liquid assets (HQLAs) to meet on-balance sheet requirements, reducing lending capacity.
During stress, it becomes pro-cyclical, as banks are reluctant to use HQLAs for fear of falling below minimum LCRs.
This exacerbates stress, forcing conversion of less liquid assets and leading to "liquidity hoarding," which imposes unnecessary costs on the banking system and the broader U.S. economy.
Underutilized discount window needs fundamental reform
The Federal Reserve's discount window, a critical but underutilized tool, requires fundamental reform.
Bowman highlights that banks avoid the discount window, even in stress, due to the stigma of disclosure and higher borrowing costs.
Markets interpret any usage as a sign of fragility, discouraging its use when needed most.
Fragmentation of rules across the 12 Reserve Banks creates uncertainty and can exacerbate fragilities.
This underutilization forces banks to hoard high-quality liquid assets rather than lending, reducing credit availability.
It also requires the Fed to maintain a larger balance sheet.
Bowman emphasizes that modernizing the discount window to serve as an effective liquidity backstop is crucial for compatible monetary policy and regulatory objectives.