The Discount Window: A Useful Liquidity Tool

By providing ready access to funding, the Federal Reserve’s discount window helps depository institutions manage their liquidity risks efficiently and avoid actions that have negative consequences for their customers, such as withdrawing credit during times of market stress. The discount window supports the smooth flow of credit to households and businesses. Providing liquidity in this way is one of the original purposes of the Federal Reserve System and other central banks around the world.

The primary credit program is the principal safety valve for ensuring adequate liquidity in the banking system and a backup source of short-term funds for generally sound depository institutions. Most depository institutions qualify for primary credit. Reserve Banks, typically, do not require depository institutions to provide reasons for requesting very short-term primary credit. Rather, borrowers are asked to provide only the minimum information necessary to process a loan, usually the amount and term of the loan. All extensions of credit must be secured to the satisfaction of the lending Reserve Bank by collateral that is acceptable for that purpose. Most performing or investment grade assets held by depository institutions are acceptable as collateral.

Being prepared to borrow from the discount window can be an important component of a depository institution’s planning for both strategic and contingency purposes. Any depository institution that expects to use the discount window should file the necessary lending agreements and corporate resolutions under the terms set forth in the Federal Reserve’s lending agreement, Operating Circular No. 10. Depository institutions that do not envision using the discount window in the ordinary course of events are encouraged to execute the necessary documents because a need for discount window credit could arise suddenly and unexpectedly. Institutions also are encouraged to contact their Reserve Bank to discuss collateral requirements and arrangements before a need to borrow arises.