The Federal Reserve Board recently adopted final regulations implementing the restrictions on its emergency lending authority contained in the 2010 Dodd-Frank regulatory reform legislation.  Instead of being able to use a broad authority to provide funds to any individual, partnership or corporation in unusual and exigent circumstances, the Federal Reserve Board will be able only to authorize a Federal Reserve Bank (jointly with the Federal Reserve Board, the “Federal Reserve”) to lend in such emergency situations through a “broad-based” lending program or facility.

In response to criticism by some on the use of the Federal Reserve section 13(3) lending authority during the recent financial crisis, in Dodd-Frank, Congress eliminated the ability of the Federal Reserve to lend to any one borrower. Instead, under revised Section 13(3), the Federal Reserve emergency lending authority is limited to participants in a “program or facility with broad-based eligibility” in order to provide liquidity to the financial system.

The final rule sets out detailed criteria on use of the authority in establishing these broad-based lending programs or facilities, including the following:

  • The Secretary of the Treasury must approve the establishment of the program or facility
  • The Federal Reserve has no obligation to lend to any particular person as part of a specific program or facility
  • The Federal Reserve must notify Congress and the public of the details of, and justification for, the program or facility within 7 days of its authorization
  • To meet the requirement that a program or facility must be “broad based,” three conditions must be met: (i) it must be designed for the purpose of providing liquidity to an identifiable market or sector of the financial system; (ii) it must not be designed for the purpose of assisting one or more specific companies to avoid bankruptcy or other resolution, including by removing assets from the balance sheet of the company or companies and (iii) it would not be considered broad-based if fewer than five persons are eligible to participate
  • In addition to the requirement that a participant not be involved in an insolvency, bankruptcy or resolution proceeding, a participant must have been generally paying its bills on a timely basis for the 90 day period before borrowing under the program or facility
  • All borrowing must be secured by collateral to the satisfaction of the Federal Reserve, including any required discounts on certain of the assets pledged as collateral
  • Any program or facility must include a “penalty rate” of interest that is higher than the usual market rate under normal circumstances and encourages repayment as the unusual and exigent circumstances recede
  • A participant must provide evidence that it is unable to secure credit from other banks

A program or facility can be terminated by the Federal Reserve at any time and it will automatically terminate one year after extending its first loan. The program or facility can be extended for additional one year terms with the Treasury Secretary’s approval if the Federal Reserve finds that unusual or exigent circumstances continue and the program or facility continues to appropriately provide liquidity to the financial system. In any event, the Federal Reserve must review each program or facility every 6 months to determine whether to continue or terminate it.

The final rule is effective January 1, 2016.