What is a Discount Window?
The discount window is a central bank lending facility meant to help commercial banks manage short-term liquidity needs.
How a Discount Window Works
Discount window borrowing tends to be short-term—usually overnight—and collateralized. These loans are different from the uncollateralized lending banks with deposits at central banks do among themselves; in the U.S. these loans are made at the federal funds rate, which is lower than the discount rate.
Even foreign banks may borrow from the Federal Reserve's discount window.
Current discount rates are listed on the Federal Reserve's website.
Discount window lending is typically a short-term loan (even overnight loan), and borrowers must put down collateral for their loans.
The Federal Reserve extends discount window loans to financial institutions who, in turn, support commercial industries.
Banks borrow at the discount window when they are experiencing short-term liquidity shortfalls and need a quick cash infusion. Banks generally prefer to borrow from other banks, since the rate is cheaper and the loans do not require collateral.
The term refers to the now-obsolete practice of sending bank employees to actual, physical windows in Federal Reserve branch lobbies to ask for loans.
For this reason, discount window borrowing jumps during spells of economy-wide distress, when all banks are experiencing some degree of liquidity pressure: after the tech bubble burst in 2001, for example, borrowing at the Fed's discount window hit its highest level in 15 years.
Example of a Discount Window
The 2008 financial crisis saw the Fed's discount window take on a central role in maintaining a semblance of financial stability. Lending periods were extended from overnight to 30 days, then 90. The rate was cut to within 0.25 percentage points of the federal funds rate; the spread had previously been 1 pp, and as of November 2017, it is 0.5 pp.
In October 2008, the month after Lehman Brothers' collapse, banks borrowed $403.5 billion at the discount window; the previous recession had seen borrowing peak at $3.4 billion (September 2001).
The Fed's discount window lends at three rates; "discount rate" is shorthand for the first-rate offered to the most financially sound institutions. The three rates are defined as the primary credit rate, secondary credit rate, and seasonal discount rate. All other interest rates are affected by the discount rate including savings and money market interest rates, fixed-rate mortgages, and Libor rates.
According to the Federal Reserve website:
"Bankers' banks, corporate credit unions, and other financial institutions are not required to maintain reserves under Regulation D, and so do not have regular access to the Discount Window. However, the Board of Governors has determined that such institutions may obtain access to the Discount Window if they voluntarily maintain reserves."