The Federal Reserve has finalized a new framework for emergency lending – so-called 13(3) extensions – at significant variance from the proposal that largely restated underlying provisions in Dodd-Frank. The new approach derives from criticism that the FRB’s unwillingness to limit 13(3) advances reinforced moral hazard because the market would continue to expect Federal Reserve emergency support for troubled or even insolvent banks. Legislation recently passed by the House and pending in the Senate would have forcibly constrained 13(3) extensions and, recognizing their potency, the FRB’s final rule adopts many of their restrictions. It nonetheless remains able to support troubled firms if at least five financial institutions are eligible participants in the emergency program, as long as all of those getting 13(3) backstops are not clearly insolvent, but rather only illiquid.
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