Discount window
Encyclopedia
The discount window is an instrument of monetary policy
(usually controlled by central bank
s) that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions. The term originated with the practice of sending a bank representative to a reserve bank teller window when a bank needed to borrow money.
The interest rate
charged on such loans by a central bank is called the discount rate, base rate, or repo
rate, and should not be confused with the Prime rate
. It is also distinct from the federal funds rate
and its equivalents in other currencies, which determine the rate at which banks lend money to each other. In recent years, the discount rate has been approximately a percentage point above the federal funds rate (see Lombard credit
). Because of this, it is a relatively unimportant factor in the control of the money supply
and is only taken advantage of at large volume during emergencies.
, there are actually several different rates charged to institutions borrowing at the Discount Window. In 2006, these were: the primary credit rate (the most common), the secondary credit rate (for banks that are less financially sound), and the seasonal credit rate. The Federal Reserve does not publish information regarding institutions' eligibility for primary or secondary credit. Primary and secondary credit is normally offered on a secured overnight basis, while seasonal credit is extended up to nine months. The primary credit is normally set 100 basis points (or bp) above the federal funds target and the secondary credit rate is set 50 bp above the primary rate. The seasonal credit rate is set from an averaging of the effective fed funds rate and 90-day certificate of deposit
rates.
Institutions must provide acceptable collateral
to secure the loan.
On March 16, 2008, concurrent with measures to rescue Bear Stearns
from insolvency and to stem further institutional bank run
s, the Federal Reserve announced significant and temporary changes to primary credit lending terms. The maximum term of loans was extended from thirty days to ninety days. Less than a year before the term was only overnight. The primary credit rate was also reduced to 3.25% from 3.50%, which cut the spread of the primary credit rate over the fed funds rate to 25 basis points from 50 basis points.
, as the volume of borrowing requests increased dramatically, lending to banks through the discount window totaled about $46 billion, more than two hundred times the daily average for the previous month. The flood of funds released into the banking system reduced the immediate need for banks to rely on payments from other banks to make the payments they themselves owed others. This kept liquidity alive in the economy despite interruptions of communications and cash flow between banks.
again the volume of borrowing requests increased dramatically, and in the course of the Great Recession remains worldwide on a high level. Banks lend not directly each other, but to the central bank and, on the other side, borrow not directly from each other, but from the central bank.
the discount window is called Standing Facilities, which are used to manage overnight liquidity. Qualifying counterparties can use the Standing Facilities to increase the amount of cash they have available for overnight settlements using the Marginal Lending facility. Conversely, excess funds can be deposited within the European Central Bank
System (ECBS) and earn interest using the Deposit facility.
Counterparties must have collateral for the funds they receive from the Marginal Lending facility and will be charged the overnight rate set by the ECBS. Excess capital can be deposited with the Deposit facility and they will earn interest at the rate offered by the ECBS. The rates for these two facilities signal the central bank system’s outlook for commercial interest rates and sets the upper and lower limit for interest rates on the overnight market.
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
(usually controlled by central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
s) that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions. The term originated with the practice of sending a bank representative to a reserve bank teller window when a bank needed to borrow money.
The interest rate
Interest rate
An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for...
charged on such loans by a central bank is called the discount rate, base rate, or repo
Repurchase agreement
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively...
rate, and should not be confused with the Prime rate
Prime rate
Prime rate or prime lending rate is a term applied in many countries to a reference interest rate used by banks. The term originally indicated the rate of interest at which banks lent to favored customers, i.e., those with high credibility, though this is no longer always the case...
. It is also distinct from the federal funds rate
Federal funds rate
In the United States, the federal funds rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis. Institutions with surplus balances in their accounts lend...
and its equivalents in other currencies, which determine the rate at which banks lend money to each other. In recent years, the discount rate has been approximately a percentage point above the federal funds rate (see Lombard credit
Lombard credit
Lombard credit is the granting of credit to banks against pledged items, mostly in the form of securities or life insurance policies. The pledged items must be readily salable...
). Because of this, it is a relatively unimportant factor in the control of the money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
and is only taken advantage of at large volume during emergencies.
In the United States
In the United StatesUnited States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, there are actually several different rates charged to institutions borrowing at the Discount Window. In 2006, these were: the primary credit rate (the most common), the secondary credit rate (for banks that are less financially sound), and the seasonal credit rate. The Federal Reserve does not publish information regarding institutions' eligibility for primary or secondary credit. Primary and secondary credit is normally offered on a secured overnight basis, while seasonal credit is extended up to nine months. The primary credit is normally set 100 basis points (or bp) above the federal funds target and the secondary credit rate is set 50 bp above the primary rate. The seasonal credit rate is set from an averaging of the effective fed funds rate and 90-day certificate of deposit
Certificate of deposit
A certificate of Deposit is a time deposit, a financial product commonly offered to consumers in the United States by banks, thrift institutions, and credit unions....
rates.
Institutions must provide acceptable collateral
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...
to secure the loan.
Alterations during 2007-2009 'credit crunch'
On August 17, 2007, the Board of Governors of the Federal Reserve announced a temporary change to primary credit lending terms. The discount rate was cut by 50 bp — to 5.75% from 6.25% — and the term of loans was extended from overnight to up to thirty days. This reduced the spread of the primary credit rate over the fed funds rate from 100 basis points to 50 basis points.On March 16, 2008, concurrent with measures to rescue Bear Stearns
Bear Stearns
The Bear Stearns Companies, Inc. based in New York City, was a global investment bank and securities trading and brokerage, until its sale to JPMorgan Chase in 2008 during the global financial crisis and recession...
from insolvency and to stem further institutional bank run
Bank run
A bank run occurs when a large number of bank customers withdraw their deposits because they believe the bank is, or might become, insolvent...
s, the Federal Reserve announced significant and temporary changes to primary credit lending terms. The maximum term of loans was extended from thirty days to ninety days. Less than a year before the term was only overnight. The primary credit rate was also reduced to 3.25% from 3.50%, which cut the spread of the primary credit rate over the fed funds rate to 25 basis points from 50 basis points.
Usage after September 11, 2001
After the September 11, 2001 attacksSeptember 11, 2001 attacks
The September 11 attacks The September 11 attacks The September 11 attacks (also referred to as September 11, September 11th or 9/119/11 is pronounced "nine eleven". The slash is not part of the pronunciation...
, as the volume of borrowing requests increased dramatically, lending to banks through the discount window totaled about $46 billion, more than two hundred times the daily average for the previous month. The flood of funds released into the banking system reduced the immediate need for banks to rely on payments from other banks to make the payments they themselves owed others. This kept liquidity alive in the economy despite interruptions of communications and cash flow between banks.
Usage after September 15, 2008
With the bankruptcy of Lehman BrothersLehman Brothers
Lehman Brothers Holdings Inc. was a global financial services firm. Before declaring bankruptcy in 2008, Lehman was the fourth largest investment bank in the USA , doing business in investment banking, equity and fixed-income sales and trading Lehman Brothers Holdings Inc. (former NYSE ticker...
again the volume of borrowing requests increased dramatically, and in the course of the Great Recession remains worldwide on a high level. Banks lend not directly each other, but to the central bank and, on the other side, borrow not directly from each other, but from the central bank.
In the eurozone
In the eurozoneEurozone
The eurozone , officially called the euro area, is an economic and monetary union of seventeen European Union member states that have adopted the euro as their common currency and sole legal tender...
the discount window is called Standing Facilities, which are used to manage overnight liquidity. Qualifying counterparties can use the Standing Facilities to increase the amount of cash they have available for overnight settlements using the Marginal Lending facility. Conversely, excess funds can be deposited within the European Central Bank
European Central Bank
The European Central Bank is the institution of the European Union that administers the monetary policy of the 17 EU Eurozone member states. It is thus one of the world's most important central banks. The bank was established by the Treaty of Amsterdam in 1998, and is headquartered in Frankfurt,...
System (ECBS) and earn interest using the Deposit facility.
Counterparties must have collateral for the funds they receive from the Marginal Lending facility and will be charged the overnight rate set by the ECBS. Excess capital can be deposited with the Deposit facility and they will earn interest at the rate offered by the ECBS. The rates for these two facilities signal the central bank system’s outlook for commercial interest rates and sets the upper and lower limit for interest rates on the overnight market.