David C. Wheelock

English

Research Papers in Economics

May 2003
MonetaryTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
Replacement Windows:
New Credit Programs
at the Discount Window
T
he Federal Reserve lends directly to commercial
banks and other depository institutions (hereafter
“banks”) through its discount window. Such lending
helps ensure adequate liquidity in the banking system
and serves as a backup source of short-term funding for
banks. On January 9, 2003, the Federal Reserve introduced
new lending programs designed to better accomplish
these functions. The Fed replaced its previous programs,
“adjustment” and “extended” credit, with “primary” and
“secondary” credit programs. (The “seasonal” credit pro-
gram remains unchanged.) The new programs differ from
their predecessors in several respects, the most significant
of which are (i) that the interest rates charged for primary
and secondary credit are set above the prevailing rate for
federal funds and (ii) that banks ordinarily face few, if any,
restrictions on their use of primary credit.1
Traditionally, the Fed’s discount rate was set below the
market rate for federal funds. The volume of outstanding
discount loans was ordinarily small, however, because
the Federal Reserve prohibited banks from using discount
window loans to finance sales of federal funds or for other-
wise expanding their assets. Banks also were thought to
be reluctant to borrow from the discount window because
of a stigma associated with such borrowing. The chart
shows the levels of the discount rate and market federal
funds rate, as well as discount window borrowing as a
percentage of total reserves, for 1987-2002. Except for a
brief surge in borrowing after September 11, 2001, discount
loans rarely exceeded 1 percent of total banking system
reserves in these years, even though the discount rate was
almost always less than the funds rate.
In contrast to adjustment and extended credit, primary
credit may be used for any purpose, including financing
the sale of federal funds, and banks are no longer required
to seek funds from alternative sources before requesting a
discount window loan. Primary credit, however, is available
only to sound banks—generally those with adequate capital
and supervisory ratings for safety and soundness (i.e.,
CAMELS composite ratings of 1, 2, or 3). Secondary
credit is intended for banks that are not eligible for primary
credit, and may not be used to fund an expansion of a
bank’s assets.  
The primary credit lending rate is set above the Federal
Open Market Committee’s target federal funds rate, and
the secondary credit rate is set above the primary credit
rate. Thus, the discount window should serve only as a
backup source of funds for banks, as sound banks ordinar-
ily will choose to obtain short-term funds less expensively
from the federal funds market or other market sources.
Indeed, the primary credit rate is expected to cap the market
funds rate. By introducing a separate lending program
for sound banks and imposing few restrictions on the use
of primary credit, however, the Fed has likely minimized
banks’ reluctance to borrow from the discount window.
Hence, the new credit programs are expected to ensure
that funding is readily available at the primary credit rate
in the event of a temporary shortage of liquidity in the
banking system. 
—David C. Wheelock
1For additional details about the programs, see
<http://www.frbdiscountwindow.org>.
Available on the web at research.stlouisfed.org
87Q1 89Q1 91Q1 93Q1 95Q1 97Q1 99Q1 01Q1 03Q1
0
2
4
6
8
10
12
Federal Funds Rate, Discount Rate, and
Discount Window Borrowing
Quarterly Averages, 1987-2002
Percentage Points
Funds
Rate
Discount
Rate
Borrowing (percent of total reserves)

Replacement windows: new credit programs at the discount window

http://research.stlouisfed.org/publications/mt/20030501/cover.pdf

Replacement windows: new credit programs at the discount window

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Research Papers in Economics