VoxEU Column Financial Markets

The Term Auction Facility effect on liquidity risk exposure

Did the Federal Reserve act as ‘lender of last resort’ during the worst of the crisis? This column contributes to the current debate on the appropriateness and effectiveness of non-standard measures that have been taken by the Fed. Quantitatively measuring the effect of the Term Auction Facility on participating banks’ liquidity risk, it seems that, because the Term Auction Facility programme provided banks with enough time to adjust exposures on their balance sheets, the Fed did act as ‘lender of last resort’.

As the interbank credit market was under serious stress at the end of 2007, the Federal Reserve launched the Term Auction Facility (TAF) with the aim of injecting liquidity into the interbank market. Cecchetti (2007) explains that banks were reluctant to lend to other banks, mainly because of uncertainty about the asset quality on the balance sheets of the potential borrowers. Between December 2007 and March 2010, the Fed auctioned a total of $3.81 trillion collateralised funds, with maturities of 28 or 84 days.

Why the Term Auction Facility is so important

As documented by Figure 1, among the programmes launched by the Fed during the crisis, the TAF has been the most important both in terms of its length – from the fourth quarter of 2007 to the second quarter of 2010, when the last loan was paid – and the number and size of the loans provided.

Figure 1. Fed lending during the financial crisis

Notes: Weekly outstanding lending by the Federal Reserve to financial institutions through the different programmes operating during the 2007-2010 financial crisis.

Did the Fed behave as a lender of last resort in order to stabilise the banking sector (cf. Buiter and Sibert 2007a, 2007b) through TAF-like programmes? Or was it, by using these instruments, adopting what John B Taylor defined as the ‘Great Deviation’ (cf. Taylor and Williams 2008, 2009; Taylor 2009; Taylor 2010)?

A gap in the literature

The literature so far has analysed the impact of the TAF programme on interest rate spreads – the interbank market rate minus risk free rate. The results are mixed1.

That said, an analysis on bank-level data that assesses the impact of the TAF programme at the individual institutional level and, in particular, on bank liquidity risk behavior is missing. In our contribution, “TAF effect on liquidity risk exposure” (Puddu and Waelchli 2012), we try to fill this gap. In particular, we document the features of US commercial banks that received the financial sustain, and we assess the impact of the TAF on liquidity risk exposure, measured by the ratio of short-term liabilities and short-term assets.

Significant differences in the run-up of the crisis

We divide the sample of about 7000 US commercial banks into two groups, by distinguishing banks depending on whether they received TAF sustain (TAF banks), at least once between 2007 and 2010, or they did not (no-TAF banks). We find that before the crisis, in the third quarter of 2007, TAF banks show higher level of liquidity risk than the rest of the banks. These institutions therefore had a more severe maturity mismatch and were most exposed to the freezing of the interbank market, unable to roll over their short-term liabilities during the crisis. Hence, they were more likely to participate in the TAF programme. TAF banks also highlight lower levels of liquidity and cash ex ante as a fraction of total assets, and they are characterised by lower levels of capital ratio. Finally, banks that benefited from the programme are on average larger than the rest of the banks. In sum, the group of TAF banks adopted a riskier strategy with high short-term debt, higher leverage and high asset risk.

Convergence during the crisis

The liquidity risk gap between the two groups of banks is significantly reduced after the end of the programme, as documented in Figure 2a. Moreover, banks that benefited from the programme start to decrease the liquidity exposures during the quarter, or just before the quarter, when they received funds for the first time, as shown in Figure 2b. These results hold for different measures of liquidity risk.

Figure 2. Banks' average liquidity risk measures, some evidence

Notes: Figure 2a, Average of the ST LIAB / ST ASS, the dependent variable employed in the baseline model, distinguishing by TAF and no-TAF bank group. In grey the period when the TAF programme was operating. Figure 1b, For TAF banks only, average of ST LIAB / ST ASS from 20 quarters before to ten quarters after the first time the banks obtained the reserves.

Our analysis

Our econometric analysis, based on a treatment effects model, suggests that participation to the programme is more likely for banks with higher level of asset-backed securities and mortgage-backed securities and for those that are located in US states that before the crisis experienced the largest increase in the housing price index and that during the crisis registered the largest increase of non-performing loans. The access to the interbank credit market was more difficult for banks located in these states due to a lack of trust. These banks therefore replaced private credit with public credit, using TAF funds.

Our findings highlight that all banks decrease their exposure in liquidity risk, but that banks that benefited from the programme decrease faster than others. The larger the amount of reserves received, the bigger the reduction in liquidity risk. In other words, TAF banks were able to more quickly adjust the structure of their debt maturity.


Our paper contributes to the current debate on the appropriateness and effectiveness of the non-standard measures taken by the Fed and aims to analyse participating banks and quantitatively measure the effect on liquidity risk. Instead of relying on aggregate price measures that proxy liquidity risk, our study emphasises the importance of a maturity mismatch between the asset and liability side.

Our results highlight that:

  • Banks did not adopt moral hazard behaviors, at least in the sample period observed.

This result can be explained by the fact that despite the fact that TAF banks were not subject to additional controls by the Fed or any other regulator, these banks might have felt themselves ‘under scrutiny’ and might have reacted accordingly, in order to look better when reassessed later on;

  • The TAF programme provided the depository institutions with liquidity at the same time as a period of intensive restructuring on their liability side.

Therefore it is as if the TAF programme provided banks with extra time in order to adjust the exposures in their balance sheets. In this sense the Fed, through the TAF programme, acted as a lender of last resort, providing distressed banks with liquidity.

Policy implications

Our findings confirm the opinion that TAF-like programmes are appropriate during situations similar to the last financial crisis. In particular, they support the view of those who consider the TAF programme as an additional countercyclical monetary policy instrument to be included among the other instruments, such as the discount window credit programmes, employed by the Fed to provide depository institutions with liquidity (cf. Rochet and Vives 2004).

Our study stresses the importance of the liability term structure as a source of banking soundness. From this perspective, our contribution provides empirical justification to those arguments in favour of the introduction of measures for liquidity risk in international financial regulations. In particular, the new measures, implemented in the Basel III accords, such as the liquidity coverage ratio and the net stable funding ratio, go in the right direction, focusing on liquidity management for the proper functioning of the banking sector and financial markets.


Buiter, W and A Sibert (2007a), “The Central Bank as the Market Maker of last Resort: From lender of last resort to market maker of last resort”, VoxEU.org, 13 August.

Buiter, W and A Sibert (2007b), “A missed opportunity for the Fed”, VoxEU.org, 18 August.

Cecchetti, S (2007), “The Art of Crisis Management: Auctions and Swaps”, VoxEU.org, 16 December.

Puddu, S and A Waelchli (2012), “TAF Effect on Liquidity Risk Exposure”, mimeo, Study Center Gerzensee.

Rochet, J and X Vives (2004), “Coordination failures and the lender of last resort: was Bagehot right after all?”, Journal of the European Economic Association, 2(6), 1116-1147.

Sarkar, A and J Shrader (2010), “Financial amplification mechanisms and the Federal Reserve's supply of liquidity during the crisis”, Economic Policy Review, 16(1), 55-74.

Taylor, J B (2009), Getting off track: How government actions and interventions caused, prolonged, and worsened the financial crisis, volume 570, Hoover Institution Press.

Taylor, J B (2010), “Macroeconomic lessons from the Great Deviation”, NBER Macroeconomics Annual, 25(1), 387-395.

Taylor, J B and Williams J C (2008),”Further Results on a Black Swan in the Money Market”, Discussion Paper 07-046, Stanford Institute for Economic Policy Research.

Taylor, J B and Williams J C (2009), “A Black Swan in the Money Market”, American Economic Journal: Macroeconomics, 1(1), 58-83.

Wu, T (2008), “On the effectiveness of the Federal Reserve's new liquidity facilities”, Federal Reserve Bank of Dallas Working Paper, 2008-08.

1 e.g. Taylor and Williams (2009) do not find any effect, while Wu (2008) and Sarkar and Shrader (2010) find that TAF was effective.

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