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Banking

Did You Know?: The Discount Window

The discount window—a Federal Reserve lending facility—provides short-term loans to depository institutions that face temporary liquidity strains during times of stress. The discount window has three different programs: primary credit (the main program), secondary credit, and seasonal credit.

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The interest rate charged on primary credit (often referred to as the discount rate) varies but is set above the Federal Open Market Committee's federal funds target rate to provide an incentive for financially sound banks to seek funding in the market at lower rates. In the event that private market rates are prohibitively high, banks can use the discount window as an alternative funding source. (Secondary credit—extended to institutions that do not qualify for primary credit—has historically been set 50 basis points (bps) above the primary rate. The rate for seasonal credit, which is extended to institutions that experience large seasonal swings in deposits and loans, is set by averaging the fed funds rate and the interest rates on 90-day certificates of deposit.) Typically, the primary credit rate had been 100 bps above the federal funds target rate, although it is currently only 50 bps above the upper end of the target range of 0 percent to 0.25 percent. The discount window rate structure also helps in carrying out monetary policy because the discount rate should act as an upper bound on short-term interbank rates.

To obtain primary credit, a depository institution must be deemed in sound financial condition by its regional Reserve Bank. All credit provided to institutions is fully secured to the satisfaction of the lending Reserve Bank by acceptable collateral (such as U.S. Treasuries, real estate loans, or consumer loans). During the recent financial crisis, many depository institutions faced a shortage of liquidity, and many received discount window loans. In October 2008, at the height of the crisis, primary credit borrowing reached more than $100 billion and was instrumental in helping solvent institutions continue their operations. More recently, as short-term private funding markets have improved, primary credit borrowing has declined markedly, to about $5.5 billion at the end of April 2010.

The Federal Reserve Board of Governors provides a weekly report showing the total borrowing under each discount window lending program and the amount borrowed within each Federal Reserve district. To avoid exacerbating liquidity strains, the Federal Reserve does not publish information about individual institutions' discount window borrowing.

—By Mike Hammill, economic policy analysis specialist at the Atlanta Fed

July 29, 2010