Discount window
The Federal Reserve's standing facility for lending directly to banks against collateral — the backstop that is supposed to cap how high short-term rates can go.
Also called: primary credit, lender of last resort facility.
In theory no bank should ever pay more than the discount rate to borrow overnight, because it can always borrow from the Fed instead. In practice the ceiling leaks, because borrowing carries stigma.
Stigma is the window's central design problem. A bank that uses it may be read as unable to fund itself privately, so banks avoid it precisely when they most need it — the opposite of what a backstop should do.
Bagehot's rule — lend freely, against good collateral, at a penalty rate — is the doctrine behind the facility, and it is still the sharpest one-line summary of what a lender of last resort is for.
The mechanics
- Direction
- The Fed lends; the bank pledges collateral and receives newly created reserves.
- Primary credit
- Available to sound institutions, short term, at a rate above the target range.
- Euro-area analogue
- The marginal lending facility, at the top of the ECB corridor.
The common misreading
That discount window borrowing signals a failing bank. It signals a bank short of liquidity, which is not the same as short of capital — conflating the two is how a funding problem becomes a solvency problem.
Related terms
- Central bank liquidity swap lineAn arrangement under which the Federal Reserve lends dollars to another central bank against its currency, so that bank can relieve dollar funding stress among its own banks.
- Main Refinancing OperationsThe ECB's regular weekly collateralised lending to euro-area banks, and the rate charged on it — historically the Eurosystem's principal source of liquidity.
- Bank reservesDeposits that commercial banks hold at the central bank — the settlement asset banks use to pay each other, and a liability of the central bank rather than an asset it owns.
Primary sources
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