DEFINITION of Federal Reserve Credit
Federal Reserve Credit refers to the process of the Federal Reserve lending funds on a very short-term basis to member banks in order to meet their liquidity and reserve needs. By lending money to member banks, the Federal Reserve helps to maintain the steady flow of funds between consumers and banking institutions.
Federal Reserve credit is most often extended by way of the "discount window," which is the Federal Reserves primary program of lending funds to member banks. The discount rate at which banks borrow depends on the creditworthiness of each bank, as well as the overall demand for funds at any given time.
BREAKING DOWN Federal Reserve Credit
As complicated as the money system can appear to be, the concept of Federal Reserve credit is surprisingly simple. In essence, the Federal Reserve extends credit as a "swing loan" to get banks through short periods of time when their Federal Reserve requirements could not otherwise be met. It's important however, to not confuse these swing loans with any type of financial bailout. The Federal Reserve's routine procedure of lending to member banks is highly regulated and backed by the collateral of each bank borrowing the money.
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.
The Fed's discount window actually lends at three rates, which are listed below; "discount rate" is shorthand for the primary rate offered to the most financially sound institutions.
"Under the primary credit program, loans are extended for a very short term (usually overnight) to depository institutions in generally sound financial condition. Depository 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. 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," according to the Fed.
For example, in May 2018, lending rates for the Federal Reserve Bank of Chicago Discount Window were as follows: Primary Credit, 2.25%; Secondary Credit, 2.75%; and Seasonal Credit, 1.95%.