GLOSSARY OF TERMS
The current economic crisis has brought these esoteric terms into mainstream conversation.
| TERMS | | Discount Window/Discount Rate
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The term Discount Window originated back in the days when Federal Reserve banks had teller windows, or walk-up counters where transactions were made. At least one of those stations was a discount window. Bankers in need of funds would bring their loans to the Discount Window where they would sell them for less than face value. Later, the banks would repurchase the loans at full face value.
Today, Discount Window refers to the Federal Reserve Bank’s lending facility through which a bank may borrow funds on a short-term basis at a below-market rate (Discount Rate). These loans provide the bank with sufficient reserves on deposit for overnight or over the weekend. In the broader picture, it functions as a safety valve to relieve pressures in reserve markets, helps to reduce liquidity problems for banks and contributes to the basic stability of financial markets. All discount window loans are fully secured.
The Federal Reserve Banks offer three Discount Window programs to depository institutions: (1) primary credit, (2) secondary credit and (3) seasonal credit, each with its own interest rate.
1.) Primary Credit: loans are extended for a very short term (usually overnight) to banks that are in generally sound financial condition. The discount rate charged is set above the usual level of short-term market interest rates. Because primary credit is the Federal Reserve's main discount window program, at times the term "discount rate" refers to the primary credit rate.
2.) Secondary Credit: Those institutions that are not eligible for primary credit may apply for secondary credit to meet short-term liquidity needs or to resolve severe financial difficulties. The discount rate on secondary credit is a higher rate on primary credit.
3.) Seasonal Credit: is extended to relatively small depository institutions that have recurring intra-year fluctuations in funding needs, such as banks in agricultural or seasonal resort communities. The discount rate for seasonal credit is an average of selected market rates.
| Discount Rates are established by each Reserve Bank's board of directors, subject to the review and determination of the Board of Governors of the Federal Reserve System. The Discount Rates for the three lending programs are the same across all Reserve Banks except on days around a change in the rate. And the recent global financial and credit crisis has created unprecedented fluctuations in the rates.
For example, as of mid-October 2008, direct lending to commercial banks from the Federal Reserve’s Discount Window hit record levels of $441.4 billion because frozen credit conditions prevented financial institutions from providing loans to one another. And by early November lending from the Discount Window had declined to below $347 billion as primary dealers and commercial banks scaled back borrowing.
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