View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

Economic SYNOPSES
short essays and reports on the economic issues of the day
2009 ■ Number 14

Bankers Acceptances and Unconventional
Monetary Policy: FAQs
Richard G. Anderson, Vice President and Economist*
n a previous Economic Synopses essay, I suggested that
bankers’ acceptances might assist the Federal Reserve
in implementing its current “unconventional” monetary
policy. Unconventional policy refers, here, to two actions:
purchasing assets other than U.S. Treasury and agency securities or lending against collateral other than what is usually
accepted at the discount window; and being concerned with
the quantity of individual assets held, rather than only the
total size of the Fed’s monetary liabilities. Chairman
Bernanke has referred to this policy as “credit easing.” Such
policy seeks to improve the functioning of credit markets,
including short-term business finance (commercial paper),
mortgage finance, home-improvement loans, student loans,
small business loans, and others. Large volumes of such
loans traditionally have been securitized; today, however,
prospective purchasers of such loans are fearful, unable to
develop usable measures of future credit risk.

I

“Here, I answer selected questions
asked by readers of my earlier essay.”
The assets purchased (and funds loaned) as part of
unconventional policy, other things held constant, increase
the Federal Reserve’s liabilities dollar-for-dollar because
the Federal Reserve pays for the assets with checks (or the
electronic equivalent) drawn on itself. Since mid-September
2008, unconventional policy has caused extraordinary
increases in the amount of deposits held by commercial
banks at the Federal Reserve Banks. Federal Reserve policymakers argue that the increases are unimportant for the
inflation outlook because they can be quickly reversed if
and when conditions require (Bernanke, 2009). Among the
public, however, the increases have raised concern because,
historically, such rapid increases have been followed by
higher inflation.
Some analysts and commentators have suggested that it
would be desirable to invent a scheme wherein the Fed
might provide increased credit market support while mini-

mizing increases in the deposits held by banks at the Federal
Reserve. The use of bankers’ acceptances is such a scheme.
Acceptances promise to restart these markets, drawing back
into market finance the private capital that now seeks the
safety of Treasury securities or federally insured bank
deposits. At the same time, the Federal Reserve’s balance
sheet is relieved of the burden of providing the finance.
Here, I answer selected questions asked by readers of
my earlier essay.
1. Would a bankers’ acceptance (BA) program at the Fed
require any new/additional legislation?
This issue requires more investigation. So far as I am
aware, there are no provisions in the Federal Reserve Act
that would prohibit such activity. In its early history, before
the Great Depression, the Federal Reserve Banks purchased
bankers’ acceptances—that is, debts of private firms that had
been “accepted” (guaranteed) by banks or acceptance corporations and were secured to the satisfaction of the Reserve
Bank. My current proposal is quite different: A Reserve Bank
(or a special purpose corporation chartered by a Reserve
Bank) would accept the debt and then sell it to private
investors. Section 14 of the Federal Reserve Act allows the
Board of Governors to authorize “any institution” to accept
debts that, if secured to the satisfaction of the Reserve Bank,
are eligible for purchase by the Reserve Bank or acceptable
as collateral for loans from the Reserve Bank (“discounted”
by the Reserve Bank). Whether this applies to my proposal
will require a ruling from Federal Reserve legal counsel.
Historically, the Board has ruled that the accepting firm
need not be a bank, but may be a nonbank institution that
has traditionally engaged in the acceptance business. Also,
the Board has ruled that the underlying loan contract need
not be backed by physical commodities, so that the funds
borrowed may be used by a firm in its ordinary course of
business as working capital.
Important to the success of my proposal is that the
acceptance be eligible for purchase or discount by a Reserve
Bank, thereby ensuring payment at maturity. In ordinary

Economic SYNOPSES

Federal Reserve Bank of St. Louis

2

times, eligibility is governed by a number of Federal Reserve
regulations. In extraordinary times, these regulations are
swept aside when section 13(3) of the Federal Reserve Act
is invoked. Today, with section 13(3) in effect, the acceptance would have the same degree of risk as a U.S. Treasury
security.

experience valuing collateral: Within the Federal Reserve,
both the Discount Window and recently created special
purpose vehicles are actively doing so. Further, the use of
experience-based fees, as mentioned above, might speed
implementation by easing the burden of precisely valuing
heterogeneous assets.

2. Do we have any idea what the operating cost of a BA
program at the Fed might be?
Because this is a new idea, I have no cost estimate. I
would expect the cost to be similar to other newly implemented Federal Reserve programs, including ones purchasing commercial paper and lending against asset-backed
securities. An essential element is designing the acceptance
contract and valuing the assets. How should the acceptance
guarantee be priced? Should a fixed price be charged for the
acceptance guarantee? Or a variable price that is adjusted
based on performance of the underlying asset? These questions haven’t yet been answered.

5. Could a BA program be used to assist weak banking
organizations, those holding large amounts of “toxic”
or “legacy” assets that are reluctant to lend because of
uncertainty whether they can obtain funds in the future?
It is important to be mindful that an acceptance program
to support the Federal Reserve’s unconventional policy is
quite separate from the use of an acceptance program to
resolve the banking crisis. The Treasury recently proposed
a Financial Stability Program that includes forming a publicprivate partnership to acquire banks’ legacy assets. When
experience-based fees and contracts are used, the acceptance provides a flexible mechanism for distributing risk
between private investors and public guarantors. To my
knowledge, the Treasury has not considered acceptances.

3. What would be the ultimate cost, assuming widespread
use?
The cost of an acceptance plan likely is modest. Some
defaults must be expected. Appropriate fees will defray, at
least in part, the costs of defaults; perhaps they would also
defray operating expenses. Yet, fees should not be so high
as to discourage worthwhile participation since the purpose
of the program is to restart credit markets during a time of
heightened uncertainty. Setting high fees tends to disproportionately attract poorer-quality borrowers who have no
alternative, while also discouraging better-quality borrowers
that, despite quality, are shut out of financial markets because
of heightened uncertainty. One option, perhaps, is to set a
modestly high initial acceptance fee that is combined with
an experience-linked rebate if actual defaults and losses are
smaller than initially anticipated—rather like your auto
insurance company sending a rebate. It must not be forgotten, however, that losses do occur when there is risk;
taxpayers’ money will be at risk. The public purpose in
restarting credit markets must be balanced against possible
losses.
4. How quickly could a BA program begin? Would the
financial crisis be over before the program starts?
I suspect an acceptance program could be implemented
relatively soon, especially if parts were outsourced to knowledgeable banking organizations. The Federal Reserve and
private-sector financial institutions have considerable

6. Could the Federal Reserve achieve the benefits of a BA
program in a more familiar manner by use of reverse
repurchase agreements, that is, matched sale-purchases?
In such transactions, the Federal Reserve sells an asset
to a private investor with an attached agreement to buy
back the asset at a specified future price on a specific date.
Isn’t this simpler?
One advantage of an acceptance is that the purchaser of
the acceptance has a marketable financial instrument: the
acceptance contract, which is payable on maturity to the
holder. Typically, reverse repurchase agreements (RRPs) do
not have such a feature—the commitment to repurchase
the asset is with a specific investor. The investor in a RRP,
essentially, has made a loan to the Federal Reserve—and
the secondary market for loans may be thin. Also, it may
be more difficult to write experience-based contracts for
RRPs than for acceptances, that is, contracts that specifically
address the default risk. ■
Anderson, Richard G. “Bankers Acceptances: Yesterday’s Instrument to Re-Start
Today’s Credit Markets?” Federal Reserve Bank of St Louis Economic Synopses,
2009, Number 5.
Bernanke, Ben. “The Crisis and Policy Response.” The Stamp Lecture at the
London School of Economics, London, England, January 13, 2009.
*He is also a visiting scholar at the School of Business, Aston University,
Birmingham, U.K.

Posted on March 18, 2009
Views expressed do not necessarily reflect official positions of the Federal Reserve System.

research.stlouisfed.org