Discount Window: Definition and Much More from Answers.com

Wikipedia: discount window

The discount window is an instrument of monetary policy (usually controlled by central banks) 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 interest rate charged on such loans by central bank is called the discount rate, base rate, repo rate or primary rate. It is distinct from 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, and is only taken advantage of at large volume during emergencies.

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. 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 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 CD rates.

On September 18, 2007, the Board of Governors of the Federal Reserve announced ^[1] a temporary change to primary credit lending terms. The rate was cut from 100 bp above the funds target to 50 bp -- to 5.25% from 5.75% -- and the term of loans was extended from overnight to up to thirty days.

After the terrorist attacks on September 11, 2001, 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.

See also

Discount rate

External links

• Definition of the "Discount Rate" from the Federal Reserve Board's official site
• Official Discount Window website from the Federal Reserve System

References

1. ^ Federal Reserve announcement