The Discount Window

Federal Reserve Banks lend funds to depository institutions at the discount window. All depository institutions that maintain transaction accounts or nonpersonal time deposits subject to reserve requirements are entitled to borrow at the discount window. These include commercial banks, thrift institutions, and United States branches and agencies of foreign banks. Prior to the passage of the Depository Institutions Deregulation and Monetary Control Act of 1980, discount window borrowing generally had been restricted to commercial banks that were members of the Federal Reserve System.

  • Federal Reserve Banks lend funds to depository institutions at the discount window.
  • Strong, well-capitalized banks borrow under the primary credit program; other banks use the secondary credit program and pay a higher rate.
  • Relatively small banks with seasonal fluctuations in reserves can use the Fed’s seasonal credit program.

Discount Window Lending
Federal Reserve Banks lend funds to depository institutions at the discount window. All depository institutions that maintain transaction accounts or nonpersonal time deposits subject to reserve requirements are entitled to borrow at the discount window. These include commercial banks, thrift institutions, and United States branches and agencies of foreign banks. Prior to the passage of the Depository Institutions Deregulation and Monetary Control Act of 1980, discount window borrowing generally had been restricted to commercial banks that were members of the Federal Reserve System.

Reserve Banks have three lending programs for depository institutions—primary credit, secondary credit and seasonal credit programs.

Reserve Banks extend primary credit on a short-term basis (typically overnight) to depository institutions with strong financial positions and ample capital, at a rate above the target federal funds rate. Under the administration of the discount window revised January 9, 2003, an eligible institution need not exhaust other sources of funds before coming to the discount window, nor are there restrictions on the purposes for which the borrower can use primary credit.

Reserve Banks determine eligibility for primary credit according to a set of criteria that is uniform throughout the Federal Reserve System, based mainly on the borrower’s examination ratings and capital. Supplementary information, including market-based information when available, also could be used to determine eligibility. Primary credit ordinarily is extended with minimal administrative burden on the borrower at a rate currently 100 basis points above the target federal funds rate.

A Federal Reserve Bank also may extend primary credit with maturities up to a few weeks as a backup source of funding to eligible institutions that cannot obtain such credit in the market on reasonable terms. However, longer-term extensions of primary credit are subject to greater administrative requirements than are overnight loans.

Reserve Banks offer secondary credit to institutions that do not qualify for primary credit. As with primary credit, secondary credit is available as a backup source of liquidity on a short-term basis, provided that the loan is consistent with a timely return to a reliance on market sources of funds. In January 2003, the discount rate on secondary credit rates was 50 basis points above the primary credit rate, or 150 basis points higher than the target federal funds rate.

Longer-term secondary credit also is available, if necessary, for the orderly resolution of a troubled institution. Unlike the primary credit program, secondary credit is not a minimal administration facility because Reserve Banks need to obtain sufficient information about a borrower’s financial situation to ensure that an extension of credit complies with the conditions of the program.

The Fed provides seasonal credit to small- and mid-sized depository institutions able to demonstrate a clear pattern of recurring intra-year fluctuations in funding needs. Primary users of seasonal credit are small depository institutions in agricultural communities. Resort-area banks are another, though less significant, user of seasonal credit. An interest rate that varies with the level of short-term market interest rates is applied to seasonal credit.

Discount window loans are secured by collateral that exceeds the amount of the loans. In 1999, the Federal Reserve expanded the range of acceptable collateral to include such items as investment-grade certificates of deposit and AAA-rated commercial mortgage-backed securities. Other acceptable collateral consists of U.S. Treasury securities, state and local government securities, collateralized mortgage obligations (AAA), consumer loans, commercial and agricultural loans, and certain mortgage notes on one-to-four-family residences.

The Fed monitors borrowing by undercapitalized institutions to insure compliance with the FDIC Improvement Act of 1991, which stipulates that the Fed may not lend to a critically undercapitalized institution for more than five days beyond the date on which it became critically undercapitalized without incurring a potential liability to the FDIC.

Under unusual and exigent circumstances, a Reserve Bank has the legal authority to advance credit to individuals, partnerships, and corporations that aren’t depository institutions, after consultation with the Board of Governors of the Federal Reserve System. To do so, the Reserve Bank must first determine that credit isn’t available from other sources and that failure to provide the credit would adversely affect the economy. This authority has not been used in about 70 years.

History of Discount Window Lending
Prior to January 2003, the discount window lending consisted of adjustment credit, extended credit and seasonal credit programs. Customarily, the interest rate on adjustment credit was less than the federal funds rate, usually 25-50 basis points during the 1990s. The below-market rate for adjustment credit created incentives for an institution to borrow at the discount window. However, regulation required institutions to first exhaust other available sources of funds and explain their need for adjustment credit.

The administration of adjustment credit by Reserve Banks may have created uncertainty among some depository institutions about their access to discount window credit. Institutions that borrowed at the discount window sometimes expressed concern that borrowing at the window signaled weakness both to competitors and the Fed. Such concerns deterred some depository institutions from borrowing at the discount window during very tight money markets when doing so would have been appropriate. This, in turn, hampered the ability of the discount window to buffer shocks to the money markets.

To address some banks’ reluctance to borrow and other concerns, the Federal Reserve Board replaced the existing adjustment and extended credit programs with primary and secondary credit programs, beginning January 2003, while retaining the seasonal lending facility.

Discount Rate
The term "discount rate" usually is applied to the interest rate on primary credit available from the Federal Reserve. Under the program enacted in 2003, Reserve Banks establish the primary credit rate at least every 14 days, subject to review and determination of the Board of Governors. Reserve Banks may recommend adjustments in the rate on primary and secondary credit at their discretion, subject to the approval of Board of Governors. The revised program includes terms to facilitate a reduction in the primary credit rate in a financial emergency.

Changes in discount window policy occurred several times in recent years. For example, the Fed liberalized discount window policy in anticipation of possible Y2K-related liquidity strains in the economy. From October 1, 1999 through April 7, 2000, it established a special liquidity facility that borrowers could use without having to first seek credit elsewhere. Following the attacks on the Pentagon and World Trade Center in September 2001, the Fed again encouraged depository institutions needing liquidity to borrow from the discount widow. Reserve Banks lent $45.5 billion to depository institutions on September 12, 2001, the record for a single day.

By employing an above-market rate and restricting eligibility to generally sound institutions, the primary credit program will considerably reduce the need for the Federal Reserve to review the funding situations of borrowers and monitor the use of borrowed funds. This reduced administration, in turn, is expected to make the discount window a more attractive funding source for depository institutions when money markets tighten.

Prior to 2003, the discount rate’s importance as a tool of monetary policy was limited, because banks did little adjustment borrowing at the discount window. The effectiveness of the revised discount window lending program as a tool of monetary policy remains to be seen. 

                                          Discount Rate (%)                              Federal Funds Rates (%)
Feb 2* 2000                    5.25                                                       5.75
Mar 21 2000                    5.50                                                       6.00
May 19 2000                   6.00                                                       6.50
Jan 3 2001                      5.75                                                       6.00
Jan 4 2001                      5.50                                                       6.00
Jan 31 2001                    5.00                                                       5.50
Mar 20 2001                    4.50                                                       5.00
Apr 18 2001                     4.00                                                       4.50
May 15 2001                    3.50                                                       4.00
Jun 27 2001                    3.25                                                       3.75
Aug 21 2001                    3.00                                                       3.50
Sep 17 2001                    2.50                                                       3.00
Oct 2 2001                       2.00                                                        2.50
Nov 6 2001                      1.50                                                        2.00
Dec 11 2001                    1.25                                                       1.75
Nov 6 2002                      0.75                                                        1.25
Jan9** 2003                    2.25                                                        1.25
Jun 25 2003                    2.00                                                        1.00
Jun 30 2004                    2.25                                                        1.25
Aug 10 2004                    2.50                                                        1.50
Sep 21 2004                    2.75                                                        1.75
Nov 10 2004                    3.00                                                         2.00
Dec 14 2004                   3.25                                                          2.25

* Discount rate on adjustment credit.
** Revised discount window program begins. Reflects rate on primary credit.

August 2007

This article has been reprinted with the authorization of the Federal Reserve