The BTFP has a one year term compared to the 90 day discount window.

You’re completely right about still being stuck with the low yield paper at the end of the year and the relatively high (to the paper) interest rate in the meantime (my read is that the banks continue to hold the paper and get the yield over the year rather than handing it over to the Fed, partially offsetting the interest cost, but I’m uncertain if that’s correct).

For that reason my speculation is the BTFP will be rolled over to keep kicking the can down the road at least until the proportion of debt sitting in long-term low yield held to market assets decreases (basically via the bank version of dollar cost averaging as they buy new treasuries/MBSs over time) or interest rates drop sufficiently that the haircut on their current low yield assets meaningfully reduces.

The interest rate charge by the Fed right now is effectively making the bank realise the haircut on their paper over that year while keeping up the illusion that their assets are still worth par value. This gives the banks the liquidity they need without having to write down the value of all their HTM assets as they would have to do if they actually sold any. In reality this also means those balance sheets, assuming conditions continue rather than return to ultra low inflation (or deflationary) conditions, are overstated.

The FDIC suggests this is by around $620bn for US banks which is smallish compared to the total US banking assets of $23,245bn but sizeable when you consider the sector has “only” $2,175bn residual assets after liabilities and imagine the distribution of unrealised losses against net positions across different banks.

With that said, the interest payments of leveraging the BTFP will presumably add to liquidity pressure, while even banks not using the facility but holding low yield HTM assets will be feeling the squeeze of needing to pay depositors current interest rates backed by a portfolio weighted down by low yield paper. For that reason if things worsen it wouldn’t surprise me if the Fed dropped the interest rate fee for BTFP towards the average yield of the pledged paper, effectively turning low yield paper into current yield assets and pretending 2020-22 never happened while shoring up the profitability of banks that managed their way healthily through this saga.

What I find a little confusing is how commentators seem to think there’s no problem because banks can hold/could have held these assets to maturity and get back the par value then - that the problem is simply that people wanted their money back at the wrong time. I guess that’s true in the strict sense of “why now” but unless conditions change again the unrealised loss will be realised eventually - either in one hit by conversion to today dollars or over time by inflation. The only way I can see this not being a problem is if banks were going to keep paying depositor interest rates as if it were 2021 until these low yield assets came to maturity, but the challenge of doing that without bailing in depositor funds over that time window when someone down the street will otherwise pay something closer to the current Fed rate seems obvious. It seems like the only game once yields rose was spinning plates and wearing the loss slowly hoping their portfolio sufficiently turned over in the meantime.

As I see it in the simplest sense, a bunch of banks have traded 2021 dollars for Timeline A 2051 dollars, where Timeline A has 30 years of extremely low inflation. People have now asked for 2023 dollars back. But it turns out we now live in Timeline B where we’re looking at moderately low inflation over the next 30 years, and the value of a Timeline A 2051 dollar in 2023 dollars is around 80c.

Pretending they can sit on their low yield paper for 28 years while slowly wearing the loss against the current Fed rate, yet alone inflation, is somehow okay because they’ll have the same numeric dollars at the end seems a fallacy unless we’re assuming a hugely deflationary environment from peak population that is not current priced in by markets (i.e. speculating that we’re actually in Timeline C).

I assume given the consistency of commentators saying there would be no issue if the assets were held to maturity means I must be overlooking something.