What is a Discount Window
The discount window is a central bank lending facility meant to help commercial banks manage short-term liquidity needs.
BREAKING DOWN Discount Window
The Federal Reserve and other central banks maintain discount windows, referring to the loans they make at an administered discount rate to commercial banks and other deposit-taking firms. 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.
Banks borrow at the discount window when they are experiencing short-term liquidity shortfalls and need a quick cash infusion. (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.) Banks generally prefer to borrow from other banks, since the rate is cheaper and the loans do not require collateral. 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.
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 actually lends at three rates; "discount rate" is shorthand for the primary rate offered to the most financially sound institutions.