Borrowing at the Discount Window : What Explains Stigma after the 2003 Reforms?

In 2003 the Federal Reserve introduced a new Discount Window (DW) regime designed explicitlyto address the “stigma problem” associated with DW borrowing. However, anecdotal andempirical evidence suggests that the reluctance by banks to access the DW persisted after 2003,even during the Global Financial Crisis when banks faced serious liquidity shortages. In thisstudy, we provide the first test of existing theories that attempt to explain the existence of DWstigma. For identification, we exploit a legally determined rotation policy that assigns federaland state supervisors to the same bank at exogenously set time intervals. Using proprietarydata from the Federal Reserve, we show that (1) DW borrowing contains information aboutfuture bank underperformance that is not contained in publicly available data, and (2) despitethe information content of DW borrowing, there is no evidence that DW borrowing by a bankcreates an adverse reaction by markets or banking supervisors. Thus, the results show thatneither the market channel nor the supervisory channel explains post-2003 stigma, which impliesthat stigma is a legacy of earlier DW regimes. Our findings suggest that the most effectivepolicy to eliminate stigma would require mandatory DW borrowing by all banks on a regular,yet random basis