The rapid withdrawal of deposits during the banking crisis in March 2023 underscores the critical role that the Federal Reserve's discount window plays in maintaining financial stability. This article delves into the challenges surrounding the use of the discount window, particularly the stigma associated with borrowing from it, and examines how this issue has evolved over time.

One of the key concerns for banks is the potential perception of financial weakness when they borrow from the discount window. Historically, this stigma has discouraged banks from utilizing this resource, despite its importance in times of crisis. To understand whether this stigma persists, researchers have analyzed transaction-level data from the federal funds market, focusing on the premium banks are willing to pay to avoid borrowing from the discount window. This analysis provides valuable insights into the presence of stigma and its impact on financial institutions.

Before the COVID-19 pandemic, there was minimal evidence of stigma, with less than 0.1 percent of federal funds transactions occurring above the primary credit rate. However, the onset of the pandemic marked a significant shift. Between March 11 and March 31, 2020, nearly 28 percent of federal funds borrowing exceeded the primary credit rate. This trend persisted through various financial disruptions, including the banking turmoil in 2023. Notably, the average size of the stigma spread more than doubled in the weeks following the failure of Silicon Valley Bank (SVB).

Realized stigma is not just a concern for troubled banks; it also serves as an early warning sign for potential failures. Banks that exhibited signs of stigma between 2014 and 2024 were three times more likely to fail over the same period. Moreover, out of the twenty-two banks that faced runs during the 2023 banking turmoil, nine had experienced realized stigma in the preceding ninety days. These findings highlight the ongoing relevance of discount window stigma and its implications for financial stability.

To further explore the factors driving realized stigma, researchers conducted a statistical analysis. The results revealed a persistent pattern: banks that borrowed federal funds above the discount window rate were about 40 percent more likely to do so again the following month. Additionally, banks that increased in size, became financially weaker, or saw a decline in alternative funding sources were significantly more likely to exhibit realized stigma. These determinants underscore the complex interplay between bank behavior and market perceptions.

In conclusion, the evidence presented demonstrates that discount window stigma remains a pertinent issue in modern banking. Addressing this stigma is crucial for enhancing the effectiveness of the discount window as a tool for maintaining financial stability. By fostering a better understanding of the factors contributing to stigma, policymakers can work towards creating a more resilient financial system that supports both banks and the broader economy.