Related links: http://www.richmondfed.org/publications/research/region_focus/2011/q1/federal_reserve_weblinks.cfmDiscount window ; Banks and banking

Renee Courtois Haltom

English

Research Papers in Economics

O
ne of the primary ways central banks can stabilize
the financial system in times of distress is by acting
as the “lender of last resort” to financial institu-
tions when funding dries up. Banks that face a liquidity
shortage may be unable to provide depositors with the
funds they wish to withdraw. At an extreme, the bank could
fail. Banks facing shortages can go the Fed’s discount
window, and that can help avoid unnecessary failures.
Yet banks aren’t always willing to take the Fed up on this
offer. During the recent financial crisis, for example, the Fed
did everything it could to encourage bank borrowing, from
easing lending terms to publicly urging banks to take loans if
needed. But borrowing remained low in late 2007 despite
severe liquidity shortages in the financial system.
A common explanation for the reluctance of banks to
borrow from the Fed is a “stigma” attached to the discount
window. This stigma is based on the notion that only a bank
in financial trouble would go to the Fed over other, cheaper
sources of funds. Banks are believed to fear that regulators,
investors, or other banks will assume the worst if the bank is
discovered to have borrowed from the Fed. There can be
perfectly benign reasons for accessing the discount window:
a bank that receives a large withdrawal too late in the day to
locate a private lender, for example. The problem is that
such stigma, if present, may hamper the Fed’s ability to 
provide liquidity in a crisis. 
Other institutions will not necessarily know when a bank
borrows from the discount window. Banks may sometimes
be able to figure out the identities of
specific borrowers, but only the total
amount of borrowing from each
regional Federal Reserve district is
made public; those data are published
weekly in the Fed’s H.4.1 release. 
That’s about to change. The Dodd-
Frank financial reform legislation
passed in the summer of 2010 requires
the Fed to publicize the names of all
banks that borrow from the discount
window and the total amount bor-
rowed, two years after that borrowing
takes place. It is too soon to tell
whether the certainty that discount
window loans will be made public will
further dissuade banks from borrow-
ing in times of need.
Borrowing From Dad
Three types of loans are offered
through the discount window. Stigma
is usually discussed in the context of primary credit, which is
available to healthy financial institutions. This is the Fed’s
principal means of adding liquidity to the banking system.
At the height of the financial crisis in October 2008, the 
Fed granted a weekly average of $111 billion in primary 
credit, a record (the previous record was about $12 billion 
for the week of Sept. 11, 2001). 
It is difficult to prove that stigma exists. Stigma would
manifest itself through banks not borrowing from the Fed.
However, it would be difficult to distinguish that from the
fact that financial institutions usually have viable funding
alternatives that are cheaper. 
Banks rely most heavily on other banks for short-term
funding through the federal funds market. Banks have to
keep a certain amount of cash, known as reserves, on hand
according to the Fed’s reserve requirements, equal to 10 per-
cent of total deposits in most cases. But since a bank’s
depositors withdraw their funds at will, the amount of
reserves on hand fluctuates from day to day. There’s an
opportunity cost for holding “excess” reserves — banks
could lend those funds out and earn interest — so banks 
generally try to minimize the amount they hold. (The Fed
started paying interest on reserves in late 2008, which
lessens that opportunity cost some.)
That’s where the fed funds market comes in. Banks that
have an excess supply of funds become lenders, and banks
that need to fill a sudden shortfall become borrowers. Banks
have existing legal agreements in place, and simply call each
other up when they want to trade
funds. That’s why it wouldn’t be diffi-
cult for other financial institutions to
identify discount window borrowing,
says Becky Snider, who oversees the
Richmond Fed’s discount window. 
“If an institution suddenly disappears
from the fed funds market, other
banks might assume, particularly if
Richmond posts a large borrowing in
that period, that they went to the
Fed.”
The Fed would much prefer that
banks obtain funds from this private
source. But banks are rational, and
one would expect them to go 
to whichever funding source is 
cheapest. Prior to 2003, that was the
discount window. The Fed kept the
discount rate below the target fed
funds rate and limited arbitrage by
scrutinizing the banks that borrowed.
FEDERALRESERVE
Stigma and the Discount Window
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6 Region Focus | First Quarter | 2011 
In its early days, the discount window was a
physical window located within each regional
Federal Reserve Bank, as shown in this 1960s
photo of the window inside the New York Fed.
BY RENEE COURTOIS HALTOM BY RENEE COURTOIS HALTOMThe Fed required all discount window borrowers to show
that they had sought loans on the fed funds market first, and
banks had to provide information on what business activi-
ties the loans would be funding. Perhaps as a result of the
Fed’s scrutiny, going to the discount window became associ-
ated with an inability to obtain funds from other banks. 
“In my banking days, I always described it as being like
borrowing from my father,” said Fed Governor Elizabeth
Duke in an early 2010 speech. Duke had a long career as a
banker before being appointed to the Board of Governors in
2008. “I was always sure that at some point I would have to
answer uncomfortable questions.” 
Evidence of Stigma
Since stigma is latent during times of more or less normal
market functioning, when there are plenty of funding alter-
natives to the discount window, economic research that
attempts to measure the quantitative impact of stigma has
focused on unique events in financial markets. One example
was around the turn of the millennium, when businesses of
all types were worried that the date turnover would trigger a
glitch in computer systems. As a preventative measure, many
banks chose to hold extra reserves. The Fed met the added
demand for liquidity by creating the Y2K Special Lending
Facility. The SLF was specifically designed to sidestep stig-
ma: Borrowers did not need to approach the fed funds
market first, they weren’t restricted in how the fund were
used, and they didn’t have to pay the funds back right away.
The Fed encouraged banks to use the SLF without a fear
that it would trigger fears of insolvency or intensified over-
sight on the part of the Fed.
Nonetheless, lending patterns through the SLF provided
strong evidence of stigma, economist Craig Furfine of
Northwestern University found in 2001. He applied an algo-
rithm to confidential fed funds data to identify the total
volume of fed funds loans compared to those through SLF.
The results were striking: During one particular week in late
1999, SLF borrowing was $236 million, while borrowing
through the fed funds market at rates higher than the SLF
rate exceeded $1.5 billion, more than 6.5 times larger, he
found. Banks were willing to pay a sometimes hefty premi-
um for the ability to obtain funds from anyone but the Fed.
Stigma hadn’t been given theoretical treatment until a
2010 model developed by Richmond Fed economists
Huberto Ennis and John Weinberg. They show that it can be
rational for banks to borrow elsewhere at higher rates if
costly repercussions result from going to the discount win-
dow. In their model, a bank’s ability to repay an overnight
fed funds loan depends in part on its ability to resell the
assets in its portfolio to investors. One reason a bank may go
to the discount window is if other banks, perceiving those
assets are distressed, refuse to lend at a reasonably low rate.
Meanwhile, a bank’s potential investors are unable to distin-
guish the reason for borrowing, but if they observe discount
window borrowing, they can infer with a reasonably high
probability that the cause was poor asset quality. Thus, 
borrowing from the discount window conveys a signal of
financial distress to investors, and associated banks are able
to resell their assets only at a discount. 
Changes to Reduce Stigma
In 2003, the Fed made dramatic changes to its discount win-
dow practice in part to mitigate stigma. The discount rate
was changed to a constant one-percentage point spread
above the target fed funds rate, which removed the arbitrage
opportunity between the discount and fed funds rates. This
allowed the Fed to ease up on the regulatory scrutiny that
accompanied discount window borrowing. Nowadays, 
provided a bank is in good financial condition and can post
adequate collateral, discount window funds are lent on a “no
questions asked” basis. To mark the change, the Fed publicly
urged banks and other regulators to view occasional dis-
count window borrowing as appropriate and unworrisome. 
Nevertheless, evidence of stigma persists. Furfine revisit-
ed the issue after the switch. Though the Fed sets a target
level for the fed funds rate and is generally able to achieve it
through open market operations, the actual fed funds rate
can fluctuate. In principle, fed funds transactions can trade
at any rate, including above the discount rate. During the
first three months of 2003, Furfine found, an average of
more than 57 times more activity occurred in the fed funds
market at rates equal to or higher than the discount rate. 
Since discount window borrowing is rare in normal times,
markets are likely to view a bank’s sudden willingness to 
borrow as a sign of weakness when the broader market is
experiencing distress, argued Governor Duke in her
February 2010 speech. “When uncertainty about the health
of individual institutions or the industry as a whole increas-
es, stigma intensifies as the market tries to identify the
weaker players. The dilemma facing the Fed is that when 
discount window borrowing is most needed to keep credit
flowing, it is most stigmatized.”
Indeed, borrowing remained low as the financial crisis
unfolded in the second half of 2007. The Fed reduced the
spread between the discount and fed funds rates to one half
of a percentage point in August 2007, and discount loan
terms were extended from overnight to 30 days (eventually
the rates and terms were loosened further). But few banks
responded. Four of the nation’s largest banks borrowed a
combined total of more than $2 billion, but they stated pub-
licly that is was a symbolic move meant to encourage small
institutions facing liquidity shortages to borrow.
The Fed responded in December 2007 by creating an
entirely new lending facility to get liquidity to the financial
system. Like SLF, the Term Auction Facility (TAF) was
designed specifically to get around the stigma problem. 
The key difference was that TAF funds were administered
through auction. It worked like this: The Fed announced
that it would lend a fixed amount of funds, and an unlimited
number of banks could bid for up to 10 percent of 
that amount (a cap set to ensure the funds were evenly 
distributed). Funds were given to the highest bidders at the
Region Focus | First Quarter | 2011  7“stop out” rate — the rate whose associated bid exhausted
the funds. Thus, the TAF guaranteed multiple borrowers,
which reduced the likelihood that any one borrower would
be identified and penalized by the market. 
Despite the fact that discount window and TAF funds
were in principle identical — even precisely the same insti-
tutions were eligible — TAF lending quickly dwarfed that of
the discount window (see figure). During the 28 months that
TAF was operational, more than 4,200 individual loans were
granted through 60 auctions, providing more than $3.8 tril-
lion in funds. The amount offered at each auction varied
from $20 billion when the program was first launched to
more than $150 billion during the worst days of the crisis. 
There is no evidence that the market initially attached
any stigma to TAF when it was launched, writes a group of
researchers in a 2011 Federal Reserve Bank of New York
Staff Report. They document that financial institutions
were willing to pay an average premium of 37 basis points,
and 150 after the failure of investment bank Lehman
Brothers to borrow from TAF rather than the discount 
window. The fact that banks were repeatedly willing to pay
more for TAF funds is interpreted by the authors as strong,
quantitative evidence of stigma.
If one interprets all of that premium as being the result of
stigma, then stigma cost banks an average of $5.5 million in
interest per TAF auction during the summer of 2008, a 
period when the TAF rate was consistently above the 
discount rate — and $75 million in interest for the auction
immediately following the failure of Lehman. It appears
stigma has the potential to be quite costly for banks in times
of greater liquidity needs.
What Will Happen After Dodd-Frank?
An outstanding question is how the financial crisis will
affect stigma. Will it worsen it by forever associating Fed
loans with financial turbulence? Or lessen it by making 
central bank loans more common, as is the case in other
countries?
Adding a twist of uncertainty is the requirement under
the Dodd-Frank law that discount window loans be pub-
lished with a two-year lag. It is possible that the effects of
publication will be different for stigma during “normal”
times versus stigma during times of financial distress. There
appears to be a clear difference between the two. As
Governor Duke and the New York Fed’s TAF study each
suggest, financial turmoil seems to worsen stigma as uncer-
tainty rises and banks struggle to identify weaker
counterparties. Will loans being made public two years after
the fact affect banks’ willingness to borrow in a crisis? 
We may not know until the next financial panic.
Dodd-Frank was not the only recent mandate for the Fed
to reveal discount window borrowing. Lawsuits filed under
the Freedom of Information Act by the news organizations
Bloomberg and Fox News sought to require the Fed to dis-
close discount window borrowing that occurred during the
financial crisis — during April and May 2008 (around the 
failure of Bear Stearns), and from August 2007 through
November 2008, respectively. 
The Fed denied the requests under the argument that
disclosure would dissuade banks from accessing the dis-
count window. The U.S. Court of Appeals for the Second
Circuit ruled against the Fed in the Bloomberg case, and in
March of 2011, the Supreme Court denied the Fed’s petition
to hear that case. The Fed subsequently released the data.
The lawsuits are the first of their kind leading to publication
of discount window data, according to Alan Meltzer, a Fed
historian at Carnegie Mellon University.
As for more normal times, whether stigma deters bor-
rowing can come down to the culture of an individual bank,
says Snider of the Richmond Fed. “There are two different
groups: For some banks, no matter what, they will never
come to the discount widow. Then you’ve got a group to
which it appears to make sense, especially late in the day and
when conditions are advantageous. To them, if we’re going
to publish the data in two years, that doesn’t seem like a big
deal.” Still, she says, the Richmond Fed made efforts to
make sure that each of the hundreds of depository institu-
tions in the Fifth District which potentially have access to
the discount window were aware of the coming change.
Ultimately, Snider says, “what banks should remember is
that if a bank borrows from the discount window, that
means it met the Fed’s criteria for primary credit: It is a 
fundamentally healthy institution.”  RF
8 Region Focus | First Quarter | 2011 
600,000
0
500,000
400,000
300,000
200,000
100,000
Aug. 2007 Aug. 2008 Aug. 2009 Aug. 2010
Term Auction Facility
Discount Window
Apr. 2011
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Fed Lending During the Financial Crisis
Banks proved much more willing to borrow from the Term Auction Facility,
which was specifically designed to sidestep the stigma problem that is
believed to afflict the discount window.
SOURCE: Federal Reserve Board of Goverors H.4.1 Release (Factors Affecting 
Reserve Balances)
R EADINGS
Armantier, Olivier, Eric Ghysels, Asani Sarkar, and Jeffrey Shrader.
“Stigma in Financial Markets: Evidence from Liquidity Auctions
and Discount Window Borrowing During the Crisis.” Federal
Reserve Bank of New York Staff Report No. 483, January 2011.
Ennis, Huberto, and John Weinberg. “Over-the-Counter Loans,
Adverse Selection, and Stigma in the Interbank Market.”
Richmond Fed Working Paper No. 10-07, April 2010.
Furfine, Craig. “Standing Facilities and Interbank Borrowing:
Evidence from the Fed’s New Discount Window. International
Finance, November 2003, vol. 6, no. 3, pp. 329-347.

Federal Reserve: Stigma and the discount window

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Federal Reserve: Stigma and the discount window

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