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short essays and reports on the economic issues of the day
2003 ■ Number 10

Replacement Windows: New Credit Programs
at the Discount Window
David C. Wheelock
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 program 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 otherwise 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 ordinarily 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. ■

For additional details about the programs, see

Federal Funds Rate, Discount Rate, and
Discount Window Borrowing
Quarterly Averages, 1987-2002
Percentage Points








Borrowing (percent of total reserves)





Views expressed do not necessarily reflect official positions of the Federal Reserve System.




03Q 1