Primarily operating in the United Kingdom, a discount house is a firm that buys, sells, discounts, and negotiates bills of exchange or promissory notes. This is generally performed on a large scale with transactions that also include government bonds and Treasury bills.
A discount house is also called a bill broker. In the United States, a discount house refers to a large retail store that can offer consumer durables at discounted prices because of its ability to purchase in bulk and employ expense-controlling practices.
Breaking Down Discount House
Discount houses are at the heart of London’s money market system and function to provide liquidity in the secondary money market by discounting short-term obligations for those institutions in need of funds. A discount house is a money lender that participates in the buying and discounting of bills of exchange and other financial products such as money market securities, certain government bonds, and banker's acceptances (BA). It functions to ensure that there is adequate liquidity in the money markets by providing a ready market for short-term government-guaranteed securities and other money market instruments.
A discount house specializes in discounting short-dated financial securities and acts as an intermediary between a lender and a borrower. It does this by negotiating the purchase of various certificates of deposit (CDs), commercial paper, and other money market instruments mentioned above at less than par value. Through these short-term securities, they can borrow funds from commercial banks at a rate below the market rate and lend these funds to borrowers at a slightly higher rate. The interest rate differential constitutes a profit for the discount house.
The Bank of England (BoE) deals directly with the discount houses to counteract shortages of day-to-day funds and credit in the interbank market. To regulate the money supply in the economy, the Bank conducts open market operations which involve expanding or contract the volume of assets held with the Bank. It does this by offering loans to discount houses through commercial paper or government-backed securities. The rate of interest charged on these loans is the discount rate or the rediscount rate. The discount houses use the loans to purchase money market securities from commercial banks, thereby enabling these banks to meet their temporary needs for loanable funds or for cash reserves. In so doing, the discount houses act as intermediaries between the central bank and the banking system in England.
A discount house does not necessarily have to borrow funds from the central bank first to provide loans to commercial banks. It also functions in the reverse scenario. Banks in need of funds will sell commercial paper to the discount house, which takes a small spread from the transaction. These bills can be sold to institutions with surplus cash, which provide the funds to be loaned. In turn, the Bank of England rediscounts the bills for the discount house and, thus, maintains a direct link with the money market and the prevailing interest rates in the economy. By increasing or decreasing the discount rate—the rate at which the central bank lends reserves to its banking system—the Bank of England can control the cost of borrowing and, in effect, the money supply.