Introduction: A Call for Diverse Contingency Funding

In her recent address to the ABA, Secretary of the Treasury Janet Yellen emphasized the need for the U.S. banking system to address vulnerabilities exposed by the liquidity stress events of 2023. She underscored two pivotal points: strengthening preparedness for liquidity stress and ensuring banks have diverse contingency funding sources. This mandate, while prudent, largely focused on conventional government-backed solutions that, although useful, may inadvertently crowd out viable private-sector alternatives.

Complementing Yellen’s statements, Acting Comptroller of the Currency Michael Hsu recently proposed specific, stricter liquidity requirements aimed at managing the outflows of uninsured deposits, a key stressor observed during the 2023 banking challenges. Yet, both perspectives spotlight the discount window — a facility that, while a useful safety net, could limit the role of market-driven liquidity solutions.

A more balanced approach, incorporating private market tools like reciprocal deposits, can better support banks’ preparedness while maintaining deposit diversity and stability.

The Case for Market‑Based Solutions Amid Regulatory Shifts

As liquidity risks evolve, the regulatory focus has increasingly turned toward federally insured mechanisms and contingency strategies. Secretary Yellen’s call for liquidity preparedness through “diverse sources of contingency funding” presents an opportunity to advocate for market-based tools alongside traditional backstops like the Fed discount window. In the current environment, the banking sector benefits from a range of private market solutions that complement government-backed offerings by providing flexibility and enabling banks to manage deposits more effectively.

Reciprocal deposits, for example, offer an alternative by enabling banks to spread large deposits across institutions, keeping depositors’ funds fully insured while maintaining liquidity and relationships. This service can reduce the dependency on the discount window, which — though necessary for last-resort lending — carries the risk of overshadowing market innovations that could alleviate liquidity pressures more sustainably.

The Risk of “Crowding Out” Private Market Solutions

A concern with increased regulatory reliance on the discount window is that it may “crowd out” innovative, private solutions designed to manage deposit flows under stress. Acting Comptroller Hsu’s recent proposal for banks to cover stress outflows over a five-day period relies heavily on a bank’s collateralized reserves and discount window capacity. This approach, though effective, could have the unintended consequence of deterring banks from utilizing market-based tools by making the discount window a more accessible and mandated option.

If, as Hsu suggests, large institutions are mandated to routinely test and pre-position collateral at the discount window, mid-sized and smaller banks may face pressure to consolidate deposits at larger institutions with easier access to Fed facilities. This shift could not only reduce smaller banks’ competitiveness but also leave larger institutions increasingly burdened by concentrated deposit flows, paradoxically heightening systemic risk.

In this context, CFOs and treasurers managing corporate accounts may prioritize larger banks solely because of their easier access to Fed facilities. Consequently, market-based solutions like reciprocal deposits could be underutilized despite their unique capacity to offer insurance coverage while maintaining depositor confidence.

Leveraging Diverse Contingency Funding Sources: An Opportunity for Private Solutions

Secretary Yellen’s advocacy for “diverse sources of contingency funding” represents a significant opportunity for private market innovations. By broadening the framework for liquidity resilience to include reciprocal deposits and similar tools, banks can enhance depositor protection and manage liquidity stress without over-relying on the discount window. This diversification not only reinforces financial stability but also fosters an environment where institutions of varying sizes can compete on a more level playing field, particularly when managing uninsured deposits.

Conclusion: A Balanced Path Forward

Secretary Yellen’s remarks to the ABA challenge the banking sector to confront the vulnerabilities of uninsured deposits with a diverse set of tools. While public solutions like the discount window have an essential place, they should be part of a broader strategy that includes innovative and responsible private-market solutions, which can enhance resilience across banks of all sizes.

In this post-election season, new leadership at the U.S. Treasury and the banking agencies will be considering several initiatives to improve the competitive strength and soundness of our banking system and capital markets. A balanced path forward — anchored in diverse contingency funding sources supplied by the private market — will better position banks to weather liquidity stress effectively while supporting depositors’ trust and maintaining financial stability. By emphasizing these values in their services, service providers of these private-market solutions aim to support both clients and the regulatory community in their shared pursuit of a stable and resilient banking system.