Financial Update (October-December 1997)

Fed Discount Window Provides
Credit to Depository Institutions

W here can depository institutions go when they need cash to meet their liquidity needs? One place they can turn to is the Federal Reserve's discount window.

Depository institutions can borrow money from the Fed through the discount window at each Reserve Bank for infrequent liquidity needs. All institutions that hold reserves on their customer deposits are eligible to borrow funds at the window.

The discount window has two key functions. It facilitates the balance sheet adjustments of individual institutions that face temporary, unforeseen changes in their asset-liability structure. The window also complements open market operations in managing the reserves market day to day and implementing longer-term monetary policy goals.

Balance Sheet Adjustments

The discount window received its name during the early days of the Federal Reserve System, when bankers came to their Reserve Bank's teller window to obtain credit. Today through the discount window, institutions receive three basic types of credit: adjustment credit, seasonal credit and extended credit.

Adjustment credit helps institutions meet short-term liquidity needs, for example, unexpectedly large withdrawals of deposits or operational problems. An institution can request adjustment credit through the discount window overnight or for a few days until it finds other sources of funding. For contingency purposes, institutions should have collateral pledged and borrowing agreements in place with the Fed to save time in the event that they require adjustment credit through the discount window.

Seasonal credit helps smaller institutions manage liquidity needs that arise from regular, seasonal swings in loans and deposits, such as those at agricultural banks during planting season. Extended credit can be supplied to institutions needing credit to meet longer-term liquidity needs.

The interest rate that commercial banks and other depository institutions are charged when they receive adjustment credit from the Fed's discount window is the discount rate. In the past, rates were maintained independently by each Reserve Bank. Directors at each Bank still determine the discount rate for their Bank subject to Board of Governors' approval, but rates are quickly brought into harmony nationally.

All discount window loans are secured, and banks must have satisfactory collateral to receive a loan from the window. Types of satisfactory collateral include U.S. Treasury and federal agency securities, state and local government securities, and business, consumer and other customer notes.

Role in Monetary Policy

Along with the Fed's open market operations and reserve requirements, the discount rate is one of the three tools the Fed uses to set monetary policy. While discount window lending accounts for a relatively small fraction of total reserves today, it is still an important stabilizing factor in reserves market management and in the implementation of policy.

The discount window serves as a buffer in the reserves market against unexpected day-to-day fluctuations in reserves demand and supply. When demand is unexpectedly high or the supply is low, banks can turn to the window for reserves. Thus, the availability of the window helps relieve pressures in the reserves market and reduce the extent of unexpected movements in the federal funds rate, which is the rate charged by an institution on an overnight sale of excess reserves to another depository. In addition, adjustments to the discount rate can be important in signaling shifts in the Fed's monetary policy stance.

To discuss the borrowing options, contact the Atlanta Fed's discount window office toll-free at 1-888-500-7390 or direct at 404-589-7391.

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