Discount rate (federal)
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The discount window is an instrument of
monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for federal funds, very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money s ...
(usually controlled by
central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a centra ...
s) that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of
liquidity Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity, the ease with which an asset can be sold * Accounting liquidity, the ability to meet cash obligations when due * Liq ...
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 An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, t ...
charged on such loans by a central bank is called the discount rate, policy rate, base rate, or repo rate, and is separate and distinct from the
prime rate A prime rate or prime lending rate is an interest rate used by banks, usually the interest rate at which banks lend to customers with good credit. Some variable interest rates may be expressed as a percentage above or below prime rate. Use in dif ...
. It is also not the same thing as the federal funds rate or 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 In macroeconomics, the money supply (or money stock) refers to the total volume of currency held by the public at a particular point in time. There are several ways to define "money", but standard measures usually include currency in circu ...
and is only taken advantage of at large volume during emergencies.


In the United States

In the United States, 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 A basis point (often abbreviated as bp, often pronounced as "bip" or "beep") is one hundredth of 1 percentage point. The related term ''#Permyriad, permyriad'' means one hundredth of 1 percent. Changes of interest rates are often stated in basis ...
(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 federal funds rate and 90-day
certificate of deposit A certificate of deposit (CD) is a time deposit, a financial product commonly sold by banks, thrift institutions, and credit unions in the United States. CDs differ from savings accounts in that the CD has a specific, fixed term (often one, ...
rates. Institutions must provide acceptable
collateral Collateral may refer to: Business and finance * Collateral (finance), a borrower's pledge of specific property to a lender, to secure repayment of a loan * Marketing collateral, in marketing and sales Arts, entertainment, and media * ''Collate ...
to secure the loan.


Use after September 11, 2001

After the
11 September 2001 attacks The September 11 attacks, commonly known as 9/11, were four coordinated suicide terrorist attacks carried out by al-Qaeda against the United States on Tuesday, September 11, 2001. That morning, nineteen terrorists hijacked four commerc ...
, as the volume of borrowing requests increased dramatically, lending to banks through the discount window totaled about $46 billion, more than 200 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 so they could pay what they owed others. That kept liquidity alive in the economy despite interruptions of communications and cash flow between banks.


Alterations during 2007–2009 credit crunch

On August 17, 2007, the
Board of Governors of the Federal Reserve The Board of Governors of the Federal Reserve System, commonly known as the Federal Reserve Board, is the main governing body of the Federal Reserve System. It is charged with overseeing the Federal Reserve Banks and with helping implement the m ...
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. That reduced the spread of the primary credit rate over the federal funds rate from 100 basis points to 50 basis points. On March 16, 2008, concurrent with measures to rescue
Bear Stearns The Bear Stearns Companies, Inc. was a New York-based global investment bank, securities trading and brokerage firm that failed in 2008 as part of the global financial crisis and recession, and was subsequently sold to JPMorgan Chase. The com ...
from insolvency and to stem further institutional
bank run A bank run or run on the bank occurs when many clients withdraw their money from a bank, because they believe the bank may cease to function in the near future. In other words, it is when, in a fractional-reserve banking system (where banks no ...
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 had been 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 federal funds rate to 25 basis points from 50 basis points.
The Wall Street Journal reported in November 2019 that banks were "desperate to avoid the stigma attached to accessing the window" and were "hoarding cash at levels well above what regulators require".


In the eurozone

In the
eurozone The euro area, commonly called eurozone (EZ), is a currency union of 19 member states of the European Union (EU) that have adopted the euro (€) as their primary currency and sole legal tender, and have thus fully implemented EMU pol ...
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 The European Central Bank (ECB) is the prime component of the monetary Eurosystem and the European System of Central Banks (ESCB) as well as one of seven institutions of the European Union. It is one of the world's most important centra ...
System (ECBS) and earn (or pay) 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 The overnight rate is generally the interest rate that large banks use to borrow and lend from one another in the overnight market. In some countries (the United States, for example), the overnight rate may be the rate targeted by the central ban ...
set by the ECBS. Excess capital can be deposited with the Deposit Facility and it will earn (or pay) 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.


See also

*
Bank rate Bank rate, also known as discount rate in American English, is the rate of interest which a central bank charges on its loans and advances to a commercial bank. The bank rate is known by a number of different terms depending on the country, and ...
* LIBOR-OIS spread *
Primary Dealer Credit Facility On March 17, 2008, in response to the subprime mortgage crisis and the collapse of Bear Stearns, the Federal Reserve announced the creation of a new lending facility, the Primary Dealer Credit Facility (PDCF). Eligible borrowers include all financi ...
*
TED spread The TED spread is the difference between the interest rates on interbank loans and on short-term U.S. government debt ("T-bills"). TED is an acronym formed from ''T-Bill'' and ''ED'', the ticker symbol for the Eurodollar futures contract. In ...
* ZIRP


References


External links


Definition of the "Discount Rate" from the Federal Reserve Board's official siteOfficial Discount Window website from the Federal Reserve SystemFed Kept Taps Open for Banks in CrisisHistorical documents that discuss the use, effect, or possible changes to the mechanics of the discount window.
{{Federal Reserve System Operations of central banks Federal Reserve System