Lombard credit
Encyclopedia
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. Lending is via central banks, in particular the securities 'eligible for collateral' which are registered on lists; as a general rule, the Lombard rate (interest rate) is more or less one per cent above discount rate. The pledging of securities means that the credit institutions have the opportunity of acquiring money in the short term from central banks.
One prominent role of Lombard credit is in use by the Federal Reserve System
of the United States of America. Traditionally, the discount rate
, or the rate charged by the Fed to member banks in need of funds (ostensibly to maintain the required reserve ratio), was lower than the target federal funds rate
, or the rate charged among banks for the same type of overnight credit. This meant that banks could borrow from the Central Bank
at a lower rate than they could from each other, which somewhat conflicts with the Central Bank
's role as a "lender of last resort
". A discount rate lower than the rate typically charged by another bank opened the possibility of arbitrage
and thus required extra scrutiny of potential borrowers. The Federal Reserve Board of the United States
switched to a so-called "Lombard facility," in which the discount rate is actually higher than the targeted federal funds rate, thus creating an economic incentive for banks to look elsewhere before asking to borrow from the Fed.
Etymology of the term comes from Lombards
, people who conquered Italy 6c. and settled in the northern region that became known as Lombardy
. Lombards were notable in Middle Ages throughout Western Europe as bankers and money-lenders, also pawn-brokers; London's Lombard Street (1598) originally was occupied by Lombard bankers.Etymology online
In the minds of many bank executives and market participants there is still a stigma attached to borrowing from the Discount window, so while the vast majority of federal funds loans occur below the discount rate (at or near the Target federal funds rate), there have been instances when banks have paid above-market rates (particularly, rates at or even above the discount rate) for federal funds . Some economists speculate that banks take advantage of this arbitrage opportunity by borrowing from the Fed at the discount rate and then loaning that money as federal funds to other banks at a higher rate.
One prominent role of Lombard credit is in use by the Federal Reserve System
Federal Reserve System
The Federal Reserve System is the central banking system of the United States. It was created on December 23, 1913 with the enactment of the Federal Reserve Act, largely in response to a series of financial panics, particularly a severe panic in 1907...
of the United States of America. Traditionally, the discount rate
Discount window
The discount window is an instrument of monetary policy 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...
, or the rate charged by the Fed to member banks in need of funds (ostensibly to maintain the required reserve ratio), was lower than the target 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...
, or the rate charged among banks for the same type of overnight credit. This meant that banks could borrow from the 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...
at a lower rate than they could from each other, which somewhat conflicts with the 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 role as a "lender of last resort
Lender of last resort
A lender of last resort is an institution willing to extend credit when no one else will. The term refers especially to a reserve financial institution, most often the central bank of a country, intended to avoid bankruptcy of banks or other institutions deemed systemically important or 'too big to...
". A discount rate lower than the rate typically charged by another bank opened the possibility of arbitrage
Arbitrage
In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices...
and thus required extra scrutiny of potential borrowers. The Federal Reserve Board of the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
switched to a so-called "Lombard facility," in which the discount rate is actually higher than the targeted federal funds rate, thus creating an economic incentive for banks to look elsewhere before asking to borrow from the Fed.
Etymology of the term comes from Lombards
Lombards
The Lombards , also referred to as Longobards, were a Germanic tribe of Scandinavian origin, who from 568 to 774 ruled a Kingdom in Italy...
, people who conquered Italy 6c. and settled in the northern region that became known as Lombardy
Lombardy
Lombardy is one of the 20 regions of Italy. The capital is Milan. One-sixth of Italy's population lives in Lombardy and about one fifth of Italy's GDP is produced in this region, making it the most populous and richest region in the country and one of the richest in the whole of Europe...
. Lombards were notable in Middle Ages throughout Western Europe as bankers and money-lenders, also pawn-brokers; London's Lombard Street (1598) originally was occupied by Lombard bankers.Etymology online
In the minds of many bank executives and market participants there is still a stigma attached to borrowing from the Discount window, so while the vast majority of federal funds loans occur below the discount rate (at or near the Target federal funds rate), there have been instances when banks have paid above-market rates (particularly, rates at or even above the discount rate) for federal funds . Some economists speculate that banks take advantage of this arbitrage opportunity by borrowing from the Fed at the discount rate and then loaning that money as federal funds to other banks at a higher rate.