(Bloomberg) -- Demand for a rarely used Federal Reserve facility rose to the highest level since 2020 this week, potentially signaling that one or more banks are making preparations for future liquidity strains as the central bank’s balance-sheet unwind deepens.

Counterparties tapped the Fed’s Standing Repo Facility, or SRF — where eligible banks can borrow reserves in exchange for Treasury and agency debt — for $203 million on Dec. 5. That’s the most since July 2020, but it’s a miniscule amount for a facility that at its peak attracted $153 billion in March 2020. Demand for the facility dropped back to $6 million Wednesday.

“The chatter is a specific bank just got set up for the SRF and tested it,” said Steven Zeng, a strategist at Deutsche Bank AG.

Market participants are closely watching the SRF for any signs of instability as the Fed has been unwinding its balance sheet for the past 18 months and excess liquidity is dwindling. Short-term borrowing costs rose after month-end as dealer balance sheets lacked capacity to provide funding and traders needed to finance long Treasury positions. That pushed the Secured Overnight Financing Rate, or SOFR, to a record-high 5.39% and put investors on alert for more market disruption. It was at 5.33% on Tuesday.

“It makes sense some banks are testing the pipes after the SOFR jump,” Zeng said.

Representatives from the New York Fed declined to comment. 

The central bank reintroduced repo market operations in the midst of the turmoil in September 2019 when increased government borrowing exacerbated a shortage of bank reserves. It made the backstop permanent in July 2021 at a time when the monetary authority was still adding more reserves to the financial system via quantitative easing and scarcity was far from anyone’s mind. 

Over the past two years, banks had been slow to sign up, leading some to question the efficacy of a facility that is accessible to so few institutions. Yet in the past two months, five banks have been added as counterparties to the SRF, bringing the total to 25, including the New York branch of Norinchukin Bank on Dec. 1. 

(Updates with latest SOFR level. A previous version corrected y-axis label in chart)

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