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Governor George W. Mitchell, Chairman
Governor Sherman J. Maisel
Governor William W. Sherrill
President Karl R. Bopp, Philadelphia
President Edward A. Wayne, Richmond
President Charles J. Scanlon, Chicago
President George H. Clay, Kansas City
Chairman William McC. Martin, ex officio
Members until retirement:
Governor Charles N. Shepardson, President Harry A. Shuford, St. Louis



The following report sets forth the conclusions and
recommendations of a System steering committee appointed to reappraise and, where necessary, recommend redesign of Federal Reserve lending facilities.
This report is the result of a three-year System-wide
study. The proposals for the redesign of the discount
mechanism are the product of a combination of research, experience, and judgment on the part of those
involved in the study.
The Steering Committee, made up of members of
the Board of Governors and Presidents of Federal
Reserve Banks, was chaired by Governor George W.
Mitchell. Other members included Governors Sherman J. Maisel and William W. Sherrill and Presidents
Karl R. Bopp of Philadelphia, Edward A. Wayne of
Richmond, Charles J. Scanlon of Chicago, and George
H. Clay of Kansas City. Governor Charles N. Shepardson and President Harry A. Shuford of St. Louis
served as earlier members of the Steering Committee
until their respective retirements from the System, and
I served as a member of the committee, ex officio.
A staff Secretariat had the responsibility for developing proposals for Steering Committee review,
and implementing the study outline as determined by
the parent committee. This group was chaired by
Mr. Robert C. Holland, Secretary of the Board. Serving on the Secretariat were Mr. Harold Bilby, Vice
President and Senior Adviser of the New York Reserve Bank, Mr. David C. Melnicoff, Vice President
and chief lending officer of the Philadelphia Reserve
Bank, Mr. M. H. Strothman, Jr., First Vice President
of the Minneapolis Bank, Mr. Philip E. Coldwell, now
President of the Dallas Bank, and Mr. A. B. Merritt,
First Vice President of the San Francisco Bank. Representing the Board staff were Mr. Howard Hackley,
Assistant to the Board, Mr. John Farrell, Director

of the Division of Bank Operations, and Mr. Frederic
Solomon, Director of the Division of Bank Examinations. Prior to his retirement, Mr. Ralph A. Young,
Senior Adviser to the Board and Director, Division
of International Finance, also served on the Secretariat.
Mr. Bernard Shull of the Division of Research
and Statistics was a member of this group and also
served as Director of Research Projects with primary
responsibility for the implementation and coordination of research activity in connection with the study.
Miss Prisdlla Ormsby was Secretary for the Secretariat. Others who contributed to the work of the Committee were: Mr. George Garvy, New York; Mr. Edward A. Aff, Philadelphia; Mr. Kyle K. Fossum,
Minneapolis; Mr. T. R. Plant, Dallas; Mr. John B. Williams, San Francisco; and Mr. Brenton C. Leavitt, Mr.
James C. Smith, Mr. Robert Forrestal, Mr. Walter
Doyle, Mr. John Kiley, and Mr. Robert Gemmill, all
of the Board staff. Special note should be made of
the study of discount mechanisms in other major industrialized countries, an extensive review of foreign
experience under the direction of Mr. George Garvy.
Several academic scholars also contributed to the
Committee's deliberations through conferences and
writings. These efforts were organized by Professor
Lester V. Chandler, Chairman, Department of Economics, Princeton University, and Academic Consultant to the Discount Study.
The Board is indebted to those named above and
to numerous others who have cooperated in the activities of this important and far-reaching study,
culminating in the preparation of the final report.
Wm. McC. Martin, Jr., Chairman,
Board of Governors of the Federal
Reserve System
July 15, 1968

Price: 25 cents a copy; in quantities of 10 or more sent to one
address, 20 cents each. Copies may be obtained from Publications Services, Division of Administrative Services, Board of
Governors of the Federal Reserve System, Washington, D.C.,
20551, and remittance should be made payable to the order of
the Board of Governors of the Federal Reserve System in a
form collectible at par in U.S. currency. (Stamps and coupons
not accepted)

Report of a System Committee


Summary of the Proposed Redesign of the Discount


Background of the Proposed Redesign of the Discount
A. Scope of the study
B. Historical summary of the role of the discount window
C. Need for an appropriately redesigned discount window


Short-Term Adjustment Credit
A. Basic borrowing privilege
B. Other adjustment credit


IV. Seasonal Credit Accommodation
A. Needs for seasonal credit assistance
B. Seasonal borrowing privilege





Emergency Credit Assistance
A. Emergency lending to member banks
B. The System as 'lender of last resort" to the economy
through nonmember institutions
C. Support of distressed markets through the discount
Discount Rate Policy

VII. Ancillary Recommendations of the Steering Committee
A. Provisions for coordination of discount administration
B. Changes in reserve regulations to facilitate
end-of-period reserve adjustment
C. On-going studies of means of improving the
shiftability of bank assets and liabilities


Report of a System Committee

The proposed redesign of the discount
mechanism has as its chief objective increased use of the discount window for the
purpose of facilitating short-term adjustments in bank reserve positions. A more
liberal and convenient mechanism should
enable individual member banks to adjust
to changes in fund availability in a more
orderly fashion and, in so doing, should
lessen some of the causes of instability in
financial markets without hampering overall monetary control.
Central bank lending operations can provide funds to indyvidiiaL banks on either of
two bases—continuous or intermittent. In
the first case, banks are always in debt to
the central bank, and the discount rate is
varied in accordance with economic conditions to aflfect indirectly bank lending terms
and prices. But the bulk of monetary influence is exercised by the imposition on the
lending policies of commercial banks of such
restrictions as the central bank believes suitable to the environment. This system, with
variations, is typical of many foreign countries.
In the United States, on the other hand,
banks in recent decades have not been, and,
in the view of this report, should not be,
permitted to remain continuously in debt
to the Federal Reserve. Given the highly developed character of the U.S. economy and
its financial structure, open market operations in Government securities by the central bank serve effectively as the preponder-

ant means of secular reserve provision and
the leading edge of monetary policy implementation. The role of the discount mechanism, on the other hand, is to cushion the
strains of reserve adjustment for individual
member banks and, thereby, for financial
markets. In this context the discount window can beneficially assume an increased
part of the burdens of intramonthly and
seasonal reserve adjustments which are currently borne by open market operations.
This increased use should come about both
as credit is provided more liberally to individual banks faced with these adjustment
needs and as increased numbers of banks are
led to regard the window as a useful source
of temporary or seasonal funds.
Two major and interrelated changes are
included in the general design of the proposed discount window. These are: (1) a
move toward more objectively defined terms
and conditions for discounting; and (2) the
inclusion of several complementary arrangements for borrowing at the window,
each designed to provide credit for a specific type of need. These changes look forward to a generally higher level of borrowing being done by a rotating sample of
member banks. However, such a higher level
of borrowing would not mean a corresponding increase in total reserves, since increased
borrowing would be expected to be about
offset by correspondingly smaller net System
purchases of securities in the open market.


The first of these changes will be accomplished by introducing specific quantity and
frequency limitations on a part of borrowing and by increased reliance on the discount rate. These moves will permit a
clearer and more unequivocal communication of discounting standards and limitations to member banks and will help to
insure uniformity of window operation
among districts and among banks.
No one of these types of controls can be
expected to bear the entire burden of regulating discount-window use, however. The
rate charged on borrowing, while normally
expected to have a significant influence on
a bank's use of the window, is not a dependable deterrent to excessive borrowing
under pressure and, at the extreme, may
actually become only a minor consideration. Limitations on the quantity and frequency of borrowing would also prove inadequate alone as methods of controlling
borrowing. It would be impossible to construct a matrix of limitations a priori in
such a way that they exactly accommodate,
no more and no less, the varying and often
unforeseeable needs of member banks for
discount credit. For these reasons, the move
toward objectively defined terms and conditions for lending at the window, important
as it is seen to be, cannot be completely
sufficient. Only through the application of
administrative judgment over some part of
the borrowing done at the window can the
System adequately accommodate the widely
differing needs of individual member banks,

while at the same time maintaining the
necessary monetary control.
The proposed redesign contains varied
arrangements for the Federal Reserve to
provide short-term adjustment credit, seasonal credit, and emergency credit. Shortterm adjustment credit is further divided
into the "basic borrowing privilege"—which
provides credit on an automatic basis, within
specified limits on amount and duration, to
all member banks meeting the conditions
specified in Section III—and other adjustment credit. The latter is available, under administrative control, to meet needs larger in
amount or longer in duration than can be
accommodated under the basic borrowing
privilege. Seasonal credit will be provided
to accommodate recurring demands over
and above a minimum relative amount, for
such amounts and duration as the applying
member bank is able to demonstrate a need.
The redesigned discount window provides
that the Federal Reserve will continue to
supply liberal help to its member banks in
general or isolated emergency situations. In
addition, the redesigned window recognizes,
and provides for, the necessity that—in its
role as lender of last resort to other sectors
of the economy—the Federal Reserve stand
ready, under extreme conditions, to provide
circumscribed credit assistance to a broader
spectrum of financial institutions than member banks.
Each of these various types of credit
accommodation, as well as the issue of discount rate policy, is discussed in some detail in later sections of this report.

A. Scope of the study

The Fundamental Reappraisal of the Discount Mechanism was launched in mid1965. The study has involved a review of

the effectiveness of the current discount
mechanism, an appraisal of the extent to
which operating rules might need to be
altered in view of the changing economic


environment, and the formulation of specific proposals for implementing such
changes as were found to be desirable.
The study has been under the over-all
direction of a Steering Committee made up
of three members of the Board of Governors and Presidents of four of the Federal
Reserve Banks. Under this Steering Committee, a staff Secretariat was responsible
for developing proposals for Steering Committee review and implementing the study
outline as determined by the parent committee.
Over 20 individual research projects
commissioned by the Committee provided
historical perspective and quantitative and
theoretical background for considering
policy alternatives. Most of these projects
were undertaken by members of the research staffs of the Board of Governors and
the Reserve Banks, although several papers
were also prepared by academic economists.
Central bank lending experience was reviewed closely, both in the United States and
in other major industrialized countries of
the world. The System also had the benefit
of a survey by the American Bankers Association of bank attitudes toward borrowing.
Drawing upon the results of this research,
as well as ideas and suggestions from System personnel, bankers, and academic and
other economists outside the System, the
staff Secretariat formulated specific proposals for the redesign of the discount window. These proposals, with amendments
and refinements growing out of further
discussion within the Steering Committee
and among other System personnel, are presented in this document.
B. Historical summary of the role of the
discount window

The Federal Reserve Act in its original
form contemplated use of the discount

mechanism as the principal tool of central
bank policy. In fact, the proportion of total
reserves supplied via discounting never fell
below 37 per cent during the 1920's and
reached a peak of more than 80 per cent
in 1921. During the 1920's, however, open
market operations gradually but steadily
began to displace discounting as a means
of supplying reserves to the banking system.
This trend was interrupted in the years
1928-30 and 1932-33, when discounting
was relied upon heavily by many member
banks to assist in their adjustments to the
financial pressures that developed in those
periods. After 1934, borrowing fell to negligible levels as banks became extremely
liquid, reflecting a number of influences including enhanced wariness of indebtedness
in any form, sizable reserve injections from
gold inflows, and the liberal and increasingly sophisticated use of contracyclical
open market operations. Throughout the
1940's the excess reserves accumulated during the middle and late 1930's and Federal
Reserve purchases of U.S. Government securities at pegged prices provided ample reserve funds to meet wartime and postwar
needs, and discounting activity was minimal.
The Treasury-Federal Reserve accord in
March of 1951 freed the Government securities market from pegged rates, at a time
when private demands for credit were
strong. The immediate result was an upsurge in discounting activity—although still
only to a monthly peak erf $1.6 billion, or
about 7 per cent of total reserves, in December of 1952. This increase was attributable in part to heavy loan demand but
perhaps more significantly to the profitability of borrowing under the provisions of
the excess profits tax temporarily in effect.
In ensuing years credit demands eased, and
the Government securities market continued to develop to an extent which per-


mitted effective implementation of the bulk
of policy decisions through System purchases
and sales of these assets. At the same time,
most banks held ample supplies of these
liquid securities; such holdings were an
aftermath of war financing and enabled
banks to make most adjustments in their reserve positions by selling Government securities in a generally efficient and flexible
Thus, despite the abandonment of the
open market policy of pegging rates in effect
before the accord, the discount window continued to serve only a marginal role as a supplier of reserves. It provided banks with
assistance over the peaks of temporary,
emergency, or seasonal needs for funds that
exceeded the dimensions that the banks
themselves were capable of reasonably meeting out of their own resources. To reinforce
a policy of limited bank use of the discount
window, the 1955 revision of Regulation A
was issued, placing chief reliance upon bank
reluctance to borrow, buttressed as and
where necessary by disciplinary contacts by
discount officers. Given this kind of discount
policy, open market operations could be
undertaken with a new degree of vigor and
precision, secure in the knowledge that only
marginal reserve additions would be introduced through the discount window. The
chart on page 5 shows the amounts of
Federal Reserve credit supplied by each of
the three possible means—open market
operations, discounting, and .float—over
the years, and Table 1 shows the relative
proportions supplied by each for selected
In the ensuing years, the discount window has been of less and less day-to-day
significance in the operation of the monetary system, as banks have increasingly
turned elsewhere to meet their short-term
reserve needs. Even in this marginal role,

the window has continued to fill needs which
can be met in no other way. Distributive
mechanisms among both economic and geographic sectors in the United States are
often imperfect and in some cases clearly inadequate. This results in problems of reserve distribution which the Federal Reserve
can compensate for only through a technique such as discounting. The window can
meet the temporary needs of particular
banks directly as they arise, without waiting for the sometimes sluggish distributive
mechanisms to carry credit injected into the
central money market to the point of actual
Discounting can also serve as an important adjunct to open market operations in
the implementation of monetary policy. It
is often difficult to determine in advance
the exact degree of stringency which a given
level of open market operations will create
in the banking system as a whole, and virtually impossible to predict its impact on any
single bank or group of banks. The existence of the discount mechanism, however,
provides a means for individual banks to
cushion temporarily the impact of such
policy moves and therefore enables the
Trading Desk of the Federal Reserve Bank
of New York to carry out the System's open
market operations more aggressively than
would otherwise be practicable. In addition,
(Percentage of total)


market Discountoperations







Monthly overage* of daily Figures, 1917 41














the level and dispersion of borrowing serves
as a meter of disaggregated market forces
and financial pressures, providing increased
certaintity in the implementation of monetary policy.
Apart from these functions of the discount mechanism largely concerned with
reserve creation, the window provides a
unique vehicle for direct communication between Reserve Banks and member banks.
It has the potential to make an invaluable
contribution to bankers' understanding of
monetary trends and thus to their appreciation of and cooperation with Federal Reserve policies and actions.
C. Need for an appropriately redesigned
discount window

Short-term and seasonal fluctuations in
loans and deposits are fundamental facts of
commercial banking. They can be relatively

large for individual banks and, in the absence of readily available and efficient
means of adjustment, can cause problems
not only for individual bank managements
but also for the smooth functioning of the
entire financial system.
Banks' difficulties in adjusting to such
fluctuations in their funds are compounded
by several factors. The U.S. banking system
is composed of a very large number of individual institutions, each of which is subject
to a variety of short-term pressures. In the
net aggregate, these pressures may not normally appear severe. However, the gross
size and distribution of swings in fund flows
can produce abrupt pressures on individual
banks for which they can prepare only at
the cost of excessive liquidity and a significant limitation on the credit resources they
make available to their communities. More-


over, the liquidity instruments used are dependent on financial markets and mechanisms which often do not function with sufficient speed and elasticity to guarantee that
a bank can always effect its desired adjustments through these means. And not all
member banks have adequate access to such
In those periods when all banks held
sizable volumes of liquid Government securities, they were able to effect their adjustments easily in the highly developed and
almost universally accessible secondary market for these assets, and liquidity problems
were of little concern. Since World War II,
however, non-Federal debt has generally
increased far more rapidly than Federal
debt, and bank portfolios have reflected this
trend. The supplies of liquid assets available
for reserve adjustment have been further
curtailed by the rise in the total of public
deposits which must be collateralized by the
hypothecation of specified kinds of assets,
most of which are fairly liquid.
As banks in recent years have placed a
much larger share of their resources into
municipal obligations and into business,
consumer, and mortgage loans, their supply
of readily salable assets has been less and
less of a cushion against unexpected deposit
fluctuations. Part of the answer to this problem has been found in the sale of such portfolio assets. Secondary markets for these assets are decidedly inferior to the Government
securities market, however; they range from
the municipal bond market—fairly well developed at least for the bonds of larger and
better-known municipalities, but subject to
large price fluctuations—to those for conventional mortgages and agricultural paper
—rudimentary or virtually nonexistent.
More striking has been increasing bank
resort to the issuance of short-term liquid

liabilities. This trend can be seen in the
rapid growth of the Federal funds market,
the issuance of marketable certificates of deposit and debentures, and the increasingly
heavy reliance of some money market banks
on the Euro-dollar market. All of these latter
devices, by whatever name they are known,
are quite likely to be largely outside the orbit
of the bank's service area and thus different
from the normal demand and savings deposits obtained in that area. Some of the
smaller, more isolated banks do not, and in
considerable measure cannot, effectively tap
these sources of funds. Such banks therefore
tend to hold a sizable proportion of their
assets in liquid form and as a result may be
providing less credit to their communities
than would be desirable.
This increased willingness on the part of
banks to borrow from other sources has not
been accompanied, however, by a parallel
increase in borrowing at the discount window. A considerable reluctance to borrow
from the central bank has in fact been maintained, largely through the application of the
current Regulation A, which emphasizes
that banks should resort to borrowing from
the Federal Reserve only on a short-term
basis when other sources of funds fall short
of their appropriate needs.
Thus the present window continues to
serve well to hold the volume of reserve
additions introduced through borrowing to
a minimum. However, with short-term
teserve needs of individual banks persisting
and in many cases growing, and the historically important methods of meeting
these needs declining in usefulness, very
low totals of borrowing from the Federal
Reserve are no longer consistent with optimum performance of the banking system.
Complicating these problems arising from
the changing financial environment has been
the fact that the current administration of


the discount window has not been well
understood by many commercial bankers.
Failure of the Federal Reserve to communicate clearly, consistently, and unambiguously with member banks regarding the
availability of discount-window accommodation has caused many of these banks to
view this as an uncertain source of credit. In
addition, occasional Federal Reserve counsel as to what would be regarded as appropriate adjustments for borrowing banks has
led many banks to regard the window as
having too great a potential for interfering
with bank management decisions. As a result, many banks having temporary needs
for funds often make adjustments by more
costly, less efficient avenues than that afforded through the discount window, sometimes to the detriment of adequate credit
availability for their local communities.
Furthermore, the design and language of
the current Regulation A, relying as it does
primarily upon bank reluctance to borrow
and, where necessary, administrative actions
by the Federal Reserve, provides consider-

able opportunity for differences in administration from one district to another and from
one case to another. Many of the apparent
nonuniformities of administration are considered justified, since no two borrowing
cases are identical and actions must be
adapted to fit the differing circumstances of
borrowing banks. However, comments of
participants in borrowing transactions and
such objective evidence as can be brought to
bear argue that at times such administrative
differences have been greater than could be
explained by differing circumstances of individual banks.
What emerges from this review is a picture of a Federal Reserve discount mechanism which must be modernized and redesigned if it is to play a significant role in the
changing financial environment. It is believed that the redesign of the discount window herein proposed can bring the mechanism into closer touch with the prevailing
economic climate and lead to a more effectively functioning member banking system.


The adjustment action initiated by banks
in financial markets in response to temporary loan and deposit fluctuations can at
times contribute to excessive short-run market instability, particularly since the precise
timing and amplitude of temporary swings
are not predictable. In addition, short-run
fluctuations in loans and deposits give rise
to operations that impair to some extent the
efficient operation of the financial system.
The impairment is the result of otherwise
needless transactions which commercial
bank managers must conduct in order to
maintain a margin of liquidity sufficient to
meet unforeseen swings. If the adjustment

alternatives open to the bank are limited in
number and availability, this liquidity margin may have to be disproportionately large
or costly in terms of foregone yield or potential capital loss on security sales.
For those reasons, one of the basic functions of the Federal Reserve System has
been to provide temporary additions to
commercial bank reserves through loans to
member banks, in order to cushion the
process of adjustment within the financial
mechanism. Such credit accommodation
undoubtedly leads to somewhat wider shortrun fluctuations in aggregate reserves; but
such movements, usually quickly reversed,


are regarded as less destabilizing than the
fluctuations in pressures on financial markets and institutions that would otherwise
A. Basic borrowing privilege

A key objective of the proposed redesign of
the discount mechanism is to formalize the
terms of limited and temporary access to
the window through the establishment of a
"basic borrowing privilege" for each member bank unless and until otherwise notified.
A basic borrowing privilege is defined as
access to Federal Reserve credit by member
banks upon request through the discount
window within the limits of the law and according to precisely stated limits on amounts
and frequency. To some extent, these borrowing privileges represent a formalization
of the existing practice of providing temporary credit over a period of time whenever requested by member banks, but under
existing practices neither the amount nor the
duration of such limits is specified in the
Through a basic-borrowing-privilege arrangement, however, the Federal Reserve
would make unambiguously clear to member banks the terms of their access to this
type of temporary credit. With clearly defined, precisely stated limits, a high degree
of uniformity of administration of the basic
borrowing privilege should be assured to all
member banks.
The explicit nature of the borrowing privilege arrangement will enable member banks
to use the Federal Reserve discount window
more readily when they need funds for shortterm adjustment purposes and find no more
convenient alternatives at hand at comparable cost. This facet of the redesigned mecha
nism should be particularly attractive to the
great majority of small member banks that


currently make no recourse to the discount
The Federal Reserve does not now provide permanent additions to the loanable
funds of individual banks through the discount window, and the proposal herein advanced does not alter that fundamental principle. Therefore, it is necessary to impose
some limitation on the frequency and duration of credit provided to a member bank
through a basic borrowing privilege. The
recommended operational objective is for
temporary credit accommodation to be extended over a long enough period to cushion
short-term fluctuations and permit orderly
adjustment to longer-term movements; but
not for so long as to invite procrastination
in the making of needed adjustments by
individual borrowing banks or to delay unduly the response of the banking system to
a change in general monetary policy.
On the basis of extensive review of past
bank balance sheetfluctuationsand borrowing patterns, the Steering Committee has
concluded that the above objective is appropriately served by the following limitation:
a bank shall not be empowered to draw on
its basic borrowing privilege if such borrowing would cause it to be indebted to its
Federal Reserve Bank (within or in excess
of its basic borrowing privilege, but excluding any use of its seasonal borrowing
privilege as provided on pages 14-16) in
more than—(6-13) out of the last — ( 1 3 26) reserve periods.1 The (13-26) period
interval is conceived of as a moving span;
hence, eligibility for temporary adjustment
The ranges indicated here and below extend from
those limitations felt to provide the minimum meaningful assistance to member banks to the maximums
believed compatible with the aims of monetary management. Final choices of limitations within these
ranges will be made on the basis of experience and
further deliberations.


credit under the basic borrowing privilege in the current reserve period is based
upon adjustment borrowing frequency (both
within a bank's basic borrowing privilege
and in excess of that amount) during the
immediately preceding— (12-25) periods.
The total amount of credit available to
member banks—through the temporary adjustment credit program as well as through
other types of borrowing at the discount window—must also be controllable if over-all
objectives of monetary policy are to be
achieved. In determining the maximum
credit exposure which could be tolerated,
consideration must be given not only to the
absolute amount of credit provided but also
to the potential fluctuations in borrowing
from reserve period to reserve period. The
recommended operational objective is for
basic borrowing privileges to be large enough
individually to be significant to each member bank, and large enough in the aggregate
to cushion a significant part of the swings
in market factors affecting reserves, but not
so large in total as to exceed the capacity of
open market operations to offset any excessive reserve creation or destruction resulting from the total of coincident bank
drawing on or repayment of their basic
borrowing privileges.
From the point of view of equity and
efficient administration, the distribution
of the sum total of borrowing privileges
among banks needs to be simple and fairly
stable, based on a formula that is easily verified and related in some reasonable way to
the needs and creditworthiness of the borrowing bank. All things considered, the
most practical method of establishing the
basic borrowing privilege is deemed to be
as a fixed percentage of each bank's capital
stock and surplus. The combined total of a
bank's capital stock and surplus is a conventional measure of its ability to service and

repay indebtedness. Furthermore, it is a relatively stable item, and changes therein are
promptly reported to the Reserve Banks in
connection with the required purchases of
Federal Reserve stock. Moreover, use of
capital stock and surplus as a base discriminates least against newly organized banks in
their access to the basic borrowing privilege.
The distribution of basic-borrowing-privilege access among member banks might, at
first glance, seem to be most equitably accomplished by according the same percentage of capital stock and surplus to all; however, the practicalities of a manageable swing
in aggregate credits and of vast differences in
bank size argue for higher percentage limits
on the basic borrowing privilege of small
banks than on that of large banks. A constant
percentage constraint applied to all banks
which would result in a tolerable total
credit exposure would provide so little credit
to small banks that the program would be
of relatively little use to them. If the percentage limit were increased uniformly so
as to provide a reasonable amount of credit
to most banks, the aggregate basic borrowing privilege would be excessive and could
jeopardize the ability of the Federal Reserve System to meet its monetary policy
Analytical evidence also supports such
a distinction. Studies have confirmed that,
while the largest banks often experience
wide deposit fluctutaions on a very shorttime basis, small banks tend to face relatively larger fluctuations over periods of
several weeks or longer than do large banks.
This results in the main from their more
limited opportunities for geographic and
functional diversification of depositors.
Though the empirical work done on the asset
side is thus far less extensive, these same
considerations would almost certainly apply

to loan totals. An inverse relationship between loan and deposit changes may be
traced to the fact that both bank borrowers
and depositors are influenced by common or
related factors.
On the other hand, large banks needing
to borrow funds to meet temporary outflows have more ready access to money
market sources here and even abroad. They
generally have more and cheaper alternatives because of their proximity to corporate, institutional, and governmental lenders
of funds, the continuous information flow
between themselves and these lenders, the
ability and initiative of many of their specialized money managers, and finally their
ability to tailor liability offerings to the
size and maturity preferences of a wide
range of customers.
These considerations indicate that large
banks have, on the whole, less relative need
for and greater access to external sources
of credit and therefore have less relative
need for assured short-term credit accommodation from the Federal Reserve.
Given all these considerations, and after
review of the historical borrowing experience of various classes of banks, the Steering Committee recommends granting to
each qualified member bank a basic borrowing privilege, measured by reserve period
averages, equal to the following proportions
of the bank's total capital stock and
surplus:—(20-40) per cent on the first $1
million; —(10-20) per cent on amounts between $1 million and $10 million; and
— ( 1 0 ) per cent on amounts in excess of
$10 million.
Although the maximum credit extension
which could currently result under this plan,
again a reserve-period-average basis, is estimated as approximately —($2.5-$3.8) billion, the credit actually extended under the


basic borrowing privilege would almost certainly be significantly less than this figure.
Because of the diversity of fund flows among
banks and the restriction on frequency of
use discussed above, not all banks should be
expected to be making full use of their basic
borrowing privileges in the same reserve
The initial quantitative limitations suggested above may well need to be adjusted
from time to time as experience with the use
of the basic borrowing privilege develops.
It is not intended, however, that such limitations should be changed so frequently as
to disturb orderly bank planning for the
utilization of such privileges in the course
of reserve adjustment operations.
While temporary adjustment credit under
die basic-borrowing-privilege program is to
be generally available upon request, it is
necessary to impose two specific qualifying
conditions in addition to those general conditions arising from statute. First a bank, to
be entitled to use of its basic borrowing privilege, must be in satisfactory internal condition. Otherwise access to discount window
credit will be subject to administrative review. In such cases the Reserve Bank will determine the over-all condition of the bank,
taking into consideration capital adequacy,
soundness of loans, liquidity, and quality of
management. If the Reserve Bank, after taking into account all these factors, judges
that the bank's over-all condition is too poor
to warrant access to discount credit without
administrative review, that bank's basic borrowing privilege will be withdrawn until sufficient improvement is shown in its condition. During that interval, any adjustment
borrowing which the bank undertakes at the
discount window would be immediately subject to administrative review. Notification of
such withdrawal would be given in timely


fashion, and in the absence of such direct
notification, a bank would be able to rely on
assured access to discount credit so long as it
stayed within the previously defined limits on
amount and frequency.
The second qualifying condition is an administrative rule that a bank borrowing
under its basic borrowing privilege refrain
from simultaneously providing net new
funds to the money market—specifically,
aside from possible infrequent transactions
that result from miscalculations or large,
unforeseen movements in the bank's position, it should not be a net seller of Federal
funds in the same reserve period in which it
is borrowing from a Reserve Bank. This restriction, a continuation of a policy already
in force, is retained to preclude a large dayto-day retailing operation in Federal Reserve credit obtained through the discount
window. It is recognized that banks could
undertake to accomplish much the same purpose by resort to more indirect means, but
currently the funds market is the only vehicle that can handle extensions of credit
among banks on very short notice near the
ends of reserve periods, when banks would
probably be most interested in doing so. If
obvious practices of circuitous transfers of
credit in evasion of this provision should develop, consideration will be given to broadening and strengthening the scope of the
provision commensurately.
The basic-borrowing-privilege program
is both desirable and practical. Its adoption
would serve as a clear communication to
member banks that the discount window is
changed. The program promises to contribute to more effective relations between
member banks and Federal Reserve Banks
while it improves the efficiency of the financial system in general by providing a

ready access to at least a measure of temporary adjustment credit for both large and
small member banks.
B. Other adjustment credit

The basic borrowing privilege described
in the previous section would be the normal
method of extending short-term credit to
member banks, but it is not conceived as
adequate to encompass all of the varying
credit needs of banks which justify the use
of temporary adjustment credit. Experience
has shown that circumstances will arise when
adjustment credit is required in larger
amounts or for longer duration than can be
accommodated under the limits of the basic
borrowing privilege. Such supplemental
credit should also be available on as unambiguous terms as possible. This credit, it
should be emphasized, is in addition to and
not in substitution for the other types of
credit described in this paper—namely, the
basic borrowing privilege, the seasonal borrowing privilege, and emergency credit.
Borrowing beyond the privilege limits
would be subject to administrative procedures broadly similar to those which have
been progressively developed in recent years
under existing discount arrangements. These
procedures can be thought of as a sequence
of administrative actions ranging from review, which would include informational
concern as to the nature of the borrowing
bank's portfolio policies and the sources of
its lendable funds, through conferences, during which Reserve Bank officials would consult with the management of the borrowing
bank as it endeavors to develop a solution to
its problems, to actual discipline, when the
bank would be asked to begin paying off its
In any case where a member bank, dur-

ing a consecutive —(12-26)-week period,
has received short-term adjustment credit in
any amount in more than —(6-13) weeks
(that is, when the frequency limitation on
the basic borrowing privilege is exceeded),
the Reserve Bank will appraise the situation,
perhaps in consultation with the bank, and
make a determination as to the appropriateness of continued credit extension to that
bank. This determination will be made in
light of any specific indications that a timely forthcoming paydown of Federal Reserve indebtedness will occur by reason of
expected inflows of funds or some other
orderly program of balance sheet adjustment. Even if an extension is deemed justified by the surrounding circumstances, continuous review will be maintained throughout the course of the borrowing. Should the
initial or any subsequent analysis indicate
the absence of circumstances warranting a
continued provision of supplemental credit,
the Reserve Bank will initiate action with a
view toward obtaining an appropriate adjustment. The precise timing and nature of
such administrative action will, as now, remain at the discretion of the Reserve Bank,
taking into account the circumstances in the
individual case.
In actual fact, the basic-borrowing-privilege limitation on amount may be exceeded
more often than the limitation on frequency.
The former event, like the latter, will call for
an internal review of the case. Such borrowing above base will probably occur from
time to time as a result of bank efforts to
cushion sharp temporary drains, and therefore, as now, could usually be expected to be
quickly repaid without any need for Reserve
Bank intervention. However, if the balance
sheet of the bank suggested that factors other
than such temporary drains were responsible
for the borrowing, the Reserve Bank could


undertake administrative actions and, if it
were called for, might request an early adjustment by the bank. In all cases, the scope
and thrust of the adjustment required would
be related, as it currently is, to all aspects of
the bank's position and historical borrowing
record and to the desirability of achieving
an orderly program of realignment of bank
assets and liabilities, with the choice among
alternative adjustment procedures continuing to rest with the bank's own management.
As this implies, the fact that a bank exceeds the amount or frequency limitation of
its basic borrowing privilege does not mean
that it is immediately contacted and asked to
reduce its borrowing but only that it loses
its immunity to such contact and administrative review. In contrast to the arrangements
in some foreign countries, where a line of
credit (similar in principle and design to the
basic borrowing privilege) is designed to
control total use of the discount window, the
proposed redesign includes the borrowing
privilege only as a limited source of reserves,
with supplemental borrowing taking place
from time to time as a normal occurrence,
especially on the part of larger banks. Therefore, member banks can expect to receive
such discount credit as they have a justifiable
need for, in excess of the specific limits on
the basic borrowing privilege.
An adjustment program compatible with
the bank's situation will be expected of every borrower of supplemental credit, although in the case of clearly short-term and
self-reversing fund flows this may require
little or no overt action on the part of the
borrowing bank. Supplemental adjustment
credit should be thought of as temporary,
and increasingly extended use will result in
an increasing probability that the bank will
be asked to work off its debt to the Federal


Reserve. Discount officials should be continuously informed and should undertake administrative discipline promptly in any situation where it becomes apparent that a bank
is following the practice of using supplemental adjustment credit to finance a shortterm position in money market assets.
The guidelines herein set down for the
administrative control of supplemental adjustment credit have been general and may
appear to leave too great latitude for the
exercise of discretion by discount officers.

To articulate any more specific rules or
guidelines in this document is neither practical nor desirable, however. In the light
of case-by-case decisions that would be
made under the proposed procedures and
subject to the underlying principle of equal
treatment for banks in equal circumstances,
standard operating procedures should develop in all discount offices. Thefinalsection
of this report recommends arrangements to
foster effective coordination of these procedures among all Federal Reserve offices.

A. Needs for seasonal credit assistance

Seasonal fluctuations in loans and/or deposits create asset-and-liability-management
problems which many smaller banks seem
unable to accommodate without impairing
in one way or another the quality and adequacy of banking service they offer to their
communities. Such recurring pressures, similar in nature and origin and probably to
some extent overlapping the short-term fluctuations already discussed, tend to be the
greatest in smaller communities where the
economy is frequently dominated by agriculture or by a single industry of relatively
small units. The consequence of such specialization is that the economic base in the
communities is not sufficiently diversified to
provide a supply of bank funds with adequate flexibility to meet marked seasonal
changes in loan requirements and deposit
positions. While the correspondent banking
system provides a measure of credit to some
of these communities, most often in the form
of overline arrangements for loans exceeding
the lending limit of the local banks, available
evidence clearly indicates the need for more
and in some cases differently structured
credit to meet adequately the seasonal needs

of the communities. Because of size, structure, and location, banks in small towns are
often at a relative disadvantage in obtaining
credit from other external sources, such as
the issuance of large-denomination certificates of deposit or participation in the Eurodollar or Federal funds markets.
Regulation A currently provides that discount credit may be extended on a shortterm basis to enable a member bank to adjust its asset position in cases of seasonal requirements for credit "beyond those which
can reasonably be met by use of the bank's
own resources." This policy, articulated in
the revision of Regulation A in 1955, was
adopted against the background of the
heavily liquid positions of almost all banks
during the earlier postwar years and their
consequent ability to meet most seasonal
drains effectively by selling assets.
With the passage of time, however, the
liquidity positions of banks in many of the
smaller communities described have been
markedly reduced by expanding seasonal
and secular demands for credit on the one
hand and lagging community net income
and deposit growth on the other. Particularly in agricultural areas, where credit

needs have been rising very rapidly, such
trends seem likely to continue, progressively narrowing the ability of the local
banks to meet the short-term credit demands in their communities. Despite these
trends, the discount window has continued
to provide only short-range and varying
credit assistance to member banks experiencing seasonal fluctuations.
Under these circumstances, it has become appropriate to modify present seasonal lending practices at the discount window
to provide increased assistance to member
banks in accommodating seasonal demands
upon them. The discount window can perform this function better than any other
monetary tool, since only through it can the
Federal Reserve make credit available directly where and when it is needed.
B. Seasonal borrowing privilege

It is proposed that each Federal Reserve
Bank be authorized to establish a "seasonal
borrowing privilege," renewable from one
year to the next upon submission of appropriate evidence, for any of its member
banks experiencing a seasonal need for
funds of the kind and dimensions outlined
below. The intent of the arrangement is to
provide reasonably assured credit access to
banks with definable and relatively substantial seasonal pressures for the approximate
duration of such pressures, normally expected to be several months, but possibly
ranging up to as much as 9 months in exceptional cases.
The seasonal borrowing privilege at the
discount window is limited to cases in which
the applicant member bank can demonstrate a probable recurring increase in its
need for funds, arising from expanding demand for regular customer loans or shrinking deposits, or some combination thereof,


which is expected to continue for a period
of more than 4 weeks and is of sufficient
size to be of significance in the asset and
liability management of the bank. Loan
and deposit fluctuations which are relatively
small or which do not continue for as long
as 4 weeks should be accommodated by internal bank policies or by recourse to adjustment credit assistance from the discount
window and are not deemed to qualify a
bank for special seasonal credit accommodation, despite frequency of occurrence.
The size of a bank's seasonal need for
funds within any 12 months is to be
measured by comparing the net intrayear
changes in levels of deposits and loans to
customers in the bank's market area. Since
the minimum time period is fixed at four
consecutive weeks, banks might have the option of using calendar months or, on a more
refined basis, a 4-week moving average on
which to base the estimate of their seasonal
need. Seasonal estimates would be established essentially by projecting past years'
experience, adjusted as appropriate to exclude nonrecurring movements.
In order for the bank to qualify for a seasonal borrowing privilege, its projected seasonal need for funds must exceed — ( 5 - 1 0 )
per cent of its average deposits subject to reserve requirements during the preceding calendar year. Any part of that need in excess
of this limit is eligible for financing through
the discount window subject to the other
conditions described in this section. Use of
such a "deductible" principle is designed
to encourage individual bank maintenance
of some minimum level of liquidity for purposes of flexibility and also to limit the aggregate total of seasonal borrowing privileges to an amount consistent with the aims
of over-all monetary management.


Figures in Table 2 suggest the nature of
the calculation of a seasonal credit need.
In this illustration the total swing in net
fund availability is $1.0 million, measured
from the peak of $3.0 million in January,
February, and March to the trough of $2.0
million in July, August, and September. Assuming an average level of deposits subject
to reserve requirements of $5.0 million in
the preceding calendar year, the swing
clearly exceeds the minimum level of — ( 5 10) per cent of such deposits and therefore
qualifies the bank for a seasonal borrowing
privilege. The amount of the seasonal borrowing privilege at its maximum would be
($750,000-$500,000). Credit actually
outstanding under the seasonal borrowing
privilege would be expected to follow the
pattern of gradual increase to a peak, followed by tapering off, as suggested in the
In the negotiation of a seasonal borrowing privilege, the Reserve Bank must have
in its possession evidence demonstrating
that the applying member bank has a sigTABLE 2

M h
Total cJfomer £3?
base year deposits loans





- .8
2.0|Trough - l . o
3 ;ojpeak

nificant seasonal need, what amounts of
credit it expects to need, and the expected
profile and duration of such needs. In many
cases the bulk of this evidence will already
be on file with the Reserve Bank. However,
member banks should submit with their application any supplemental evidence they
have at hand, especially with regard to
altered seasonal demands which they have
reason to expect. Such information is needed,
preferably somewhat in advance of the actual takedown of credit, not only for scheduling and maintaining internal review over
the seasonal borrowing but also to enable
the System to conduct open market operations with some foreknowledge of the approximate volume and timing of seasonal injections of reserves which are expected to
occur at the discount window. This knowledge will help to minimize the degree of unexpected fluctuation in borrowing which
could make the achievement of monetary
policy objectives more difficult,
Given a demonstrated seasonal need on
the part of a member bank, the Reserve
Bank will arrange to extend credit in the
amount and for the duration needed (within the limits previously defined). Under CUTrent law, firm arrangements are limited to
90 days duration (except in the case of discount of eligible agricultural paper, for
which the maximum duration is 9 months).
However, in the event that a member bank's
seasonal needs persist beyond the 90-day
period, the Reserve Bank will consider
sympathetically requests for further extensions of credit in accordance with the initial
seasonal credit arrangement. In no case,
however, would the duration of all seasonal
borrowings under such an arrangement be
permitted to exceed 9 consecutive months.
Under normal circumstances, the amount



of credit requested in the original arrangement should not be revised in midseason.
The intention is that drawings of the seasonal credit, in accordance with projected
needs, would be relatively firm and not subject to day-to-day or week-to-week fluctuations because of minor unexpected fund
withdrawals or additions or resort to temporarily cheaper financing elsewhere. However, it is recognized that many factors of an
unpredictable nature can accentuate or diminish the seasonal outflows, and the potentials for change, while probably not great in
the aggregate, are sufficient in the case of the
individual bank to make it impractical to bar
all readjustments in the credit arrangement.
The Reserve Bank will periodically review the performance of the borrowing
member bank, and should this review indicate that the seasonal need is not materializing as contemplated in the arrangement
or that the bank is failing to operate in line
with the arrangement in some other way,
these factors would have a definite bearing
on the Reserve Bank's evaluation of future
applications for seasonal credit accommodation on the part of that bank. However,
the Reserve Bank would also retain the
option to curtail an outstanding seasonal
credit arrangement which proves to be unneeded.

Because blocks of borrowed funds extended under seasonal credit arrangements
will not be generating pressure on the borrowing banks to adjust assets or other liabilities in order to repay promptly (as do
more conventional borrowings), they will be
supplying reserves but will otherwise be neither adding to nor subtracting from the bite
of general monetary policy. The reserve supply from takedowns of seasonal borrowing
privileges can be offset to the extent desired
by open market operations; conversely,
these blocks of seasonal credit should prove
sufficiently immune to any moderate changes
in national reserve availability—particularly if the discount rate is kept reasonably
closely in line with market rates—so as not
to offset the latter changes substantially.
Given the other needs for credit at the
smaller rural banks, for developmental capital as well as for day-to-day working capital, the more liberal granting of discount
credit for seasonal purposes is regarded as
one of the more important steps the System
can take in this field. The assurance of adequate seasonal access should help to foster
more definitive asset management by small
banks and can also be expected to assist
various larger banks which may qualify for
seasonal credit accommodation.


In its traditional central banking function,
the Federal Reserve System is the ultimate
source of liquidity to the economy. This
role carries with it the responsibility to deal
with emergency situations as they affect
both member banks and the economy generally. Severe pressures encountered by
banks and other financial institutions within the past few years, involving increasing
illiquidity and interdependence and inter-

action among such institutions, emphasize
the importance of the Federal Reserve's role
in emergency situations.
Thefinancialsystem's liquidity—excessive
in the late 1940's, more than ample in the
1950's, and reasonably adequate at the start
of the 1960's—has sometimes barely covered
requirements in recent years. The asset structure of commercial banks and savings institutions reflects this downward trend, as


do increasingly aggressive efforts on the
part of bank management to manipulate
liabilities in pursuit of liquidity. Wide interest rate fluctuations in recent years attest to these factors.
Under present conditions, sophisticated
open market operations enable the System
to head off general liquidity crises, but such
operations are less appropriate when the
System is confronted with serious financial
strains among individual firms or specialized groups of institutions. At times such
pressures may be inherent in the nature of
monetary restraint, in the sense that monetary policy actions, no matter how impersonally applied, often have, in fact, excessively harsh impacts on particular sectors
of the economy. At other times underlying
economic conditions may change in unforeseen ways, to the detriment of a particular
financial substructure. And, of course, the
possibility of local calamities or management failure affecting individual institutions
or small groups of institutions is ever-present. It is in connection with these limited
crises that the discount window can play
an effective role as "lender of last resort."
This responsibility is not construed as
placing the Federal Reserve in the position
of maintaining the financial structure in
statu quo. The System should not act to
prevent losses and impairment of capital of
particular financial institutions. If pressures develop against and impair the profitability of institutions whose operations have
become unstable, inappropriate to changing
economic conditions, or competitively disadvantaged in the marketplace, it is not the
Federal Reserve's responsibility to use its
broad monetary powers in a bail-out operation. Except in the case of member banks,
where its responsibilities are somewhat more
direct, the System should intervene in its
capacity as "lender of last resort" only when

liquidity pressures threaten to engulf whole
classes of financial institutions whose structures are sound and whose operational impairment would be seriously disruptive to
the economy.
A. Emergency lending to member banks

The Federal Reserve System has a clear
responsibility to lend to member banks in
both isolated and widespread emergency
situations. It is expected that such assistance would often have beneficial effects for
the economy as a whole, but in such cases
the immediate responsibility of the System
is directly to the member bank. This is one
of the benefits of Federal Reserve membership—paid for in a sense by the maintenance of nonearning assets in satisfaction of
reserve requirements—and a basic source of
confidence in the banking system.
Therefore, the Federal Reserve will be
prepared to give prompt and sympathetic
consideration to providing the needed credit
assistance to a troubled member bank, after
having obtained the assurance of the chartering authority that the bank is solvent and
that steps are being taken to find a solution
to its problems. Emergency credit assistance
through the discount window should be provided to member banks under essentially the
same procedures as those employed in the
case of short-term adjustment credit (in excess of the basic borrowing privilege). However, ad hoc exceptions or alterations in
these arrangements—within statutory limitations—will at times be required to deal
effectively with emergency situations.
Any member bank borrowing in an emergency situation will be under extensive administrative review. This review will include
a program of coordination with the relevant supervisory and chartering authorities
and will ordinarily take the form of counseling and such other direction as is needed

to work out of the situation. Administrative
discipline may have to be applied in the case
of an emergency caused by mismanagement or dishonesty (at least until the offending management is removed), but Federal Reserve efforts in an emergency situation would normally be geared to less drastic means of helping the member bank to
reestablish a viable position. This will, in
most cases, require credit for longer than
would be permissible under the ordinary
administration of temporary credit provision, but this will be expected and regarded
as appropriate.
B. The System as "lender of last resort" to
the economy through nonmember institutions

The role of the Federal Reserve as the
"lender of last resort" to other financial sectors of the economy may, under justifiable
circumstances, require loans to institutions
other than member banks. The apparent
general approval of recent instances of lending and offering to lend to nonmember institutions has strengthened the belief that the
System's ability to carry out this function
should be readily available for use when
needed. In contrast to the case of member
banks, however, justification for Federal
Reserve assistance to nonmember institutions must be in terms of the probable impact of failure on the economy's financial
structure. It would be most unusual for the
failure of a single institution or small group
of institutions to have such significant repercussions as to justify Federal Reserve action.2
The Federal Reserve Act places no explicit limitations on the types of institutions
eligible for direct emergency credit assist3
An exception might be made in a case where the
Federal Deposit Insurance Corporation requested
Federal Reserve assistance for a nonmember commercial bank while the FDIC carried out a program
to remedy the situation.


ance, since it authorizes direct advances to
"any individual, partnership, or corporation"; but in fact, rather stringent limitations are imposed by the requirement that
these advances be secured by "direct obligations of the United States."8 In effect this
means that, in an emergency, credit in any
significant amount could probably be extended to nonmember, at least nonbank,
institutions only by using a member bank
as a conduit. That is, the Federal Reserve
would lend funds to cooperating member
banks that would in turn make loans to
nonmember institutions. The relevant Federal agency can also sometimes serve in
the role of a conduit, so long as that agency
has lending authority and assets eligible for
Federal Reserve acquisition. Thus the current law is not prohibitive of indirect lending to nonbank institutions, although it does
involve additional arrangements and costs
over those that would be involved in direct
Decisions as to what types of institutions
will be regarded, under justifiable circumstances, as eligible for emergency credit are
best made in the light of the surrounding circumstances and relative severity of particular situations. Therefore, no inclusive or exclusive list of the types of institutions to
which emergency credit may be extended
should be established in advance of anticipated possible developments. Federal Reserve credit would be advanced to nonmember institutions only after other avenues of
relief have been exhausted. Depositary institutions, the suppliers and holders of the na8
In unusual and exigent circumstances the Board
of Governors, by the affirmative vote of at least five
members, may authorize any Federal Reserve Bank
to discount eligible paper for any individual, partnership, or corporation which is unable to obtain adequate credit accommodation from other banking
institutions. However, in practice this provision is of
little use, since nonmember institutions typically have
only very limited holdings of eligible paper.


tion's liquidity, are the most likely to encounter situations where this is necessary,
and for this reason emergency credit would
be accorded, in all but the most extraordinary circumstances, only to those institutions.
Supervised nonmember financial institutions would be required to obtain the support and assent of the relevant supervisory
agency to receive Federal Reserve emergency credit. On the other hand, the Federal Reserve should not be obligated to lend
to nonmembers merely on the request of
their supervisor. While institutions can be
declared insolvent only by the chartering
authority or the courts (and such a declaration would effectively preclude Federal Reserve lending), the System should retain the
option to reject requests for assistance even
when the other agency considers the institutions solvent.
When lending to nonmembers, the System will require, in cooperation with the
relevant supervisory agency, that the institutions develop and pursue a workable program for alleviating their difficulties and will
follow the progress of the agreed-upon program closely. Credit will be provided only at
a significant penalty rate vis-a-vis that
charged member banks. This penalty rate
can be thought of as offsetting, in part, the

cost of maintaining reserves with the System
which is continuously borne by member
C. Support of distressed markets through
the discount window

It is possible that, in periods of severe monetary stringency, markets for certain financial instruments, such as Federal, State, and
local government securities, corporate securities, and mortgages, may become so distressed by disappearance of buyer interest,
necessitous selling or "dumping" of issues,
or other influences that a crisis develops
which threatens the entire financial fabric
of the nation. Under such circumstances,
the Federal Reserve will be prepared to take
action in a variety of ways to forestall the
developing crisis.
Action through the Open Market Account, where possible, is the appropriate
means for dealing with such a widespread
problem. However, in a situation of extreme
emergency, consideration would be given
to making the discount window available to
member banks (and, more remotely, to
nonmember financial institutions) in order
to reduce necessitous sales of these assets
and thus to alleviate crisis pressures in the


The proposed redesign of the discount window contemplates an increase in the numbers of banks regarding the window as a
useful source of funds. One of the major
obstacles acknowledged to exist currently
in this area is the confusion on the part
of member banks as to the terms and
conditions for discounting. The redesign
should substantially reduce banker uncertainty by the specific quantity-and-frequency

limitations regulating the basic borrowing
privilege. But the discount rate also has a
significant role to play in this operation if
the mechanism is to result in an improved
adjustment process.
Achieving maximum effectiveness calls
for maintenance of the discount rate consistently at a level reasonably close to rates
on alternative instruments of reserve adjustment. The exact relationship to market rates

at any time will depend largely on current
monetary conditions and policy objectives,
but it would be expected that related market
rates would move higher relative to the discount rate in periods of restraint and lower
relative to the discount rate during periods
of ease.
The closer linkage of the discount rate to
market rates will probably call for more
frequent changes in the discount rate than
have been made in recent years. It is believed that such changes can be achieved by
more active communication within the System and will become easier as the pattern
of more frequent discount rate adjustments
tends to reduce the unpredictable announcement effects which often attach to a given
rate change. As banks come to regard the
window as a more liberal and useful source
of funds, with no risk of administrative pressures within the confines of the basic borrowing privilege and a clearer understanding of
the limitations attaching to other borrowing,
price will naturally become a more meaningful factor in their decisions. Thus rates on
alternative means of adjustment will tend to
cluster somewhat more closely around the
discount rate. Because a measure of administrative review will continue to attach to some
discounting, however, market rates are likely
to be somewhat above the discount rate so
long as reserves are in scarce supply and rate
relationships are allowed to seek their own
There are several limitations on using
rate as the sole or even major instrument
for control of borrowing. Complete rate flexibility is neither practical nor desirable. Under certain circumstances, too frequent or
poorly timed changes could contribute to
instability in the structure of market rates.
This could be particularly true in a period of
tightness when increasing reserve cost could
rapidly escalate market rates.


Because of the Federal Reserve's role as
the lender of last resort, the demand curve
which it faces may be somewhat different
from that applying to other lenders. Ordinarily, this difference should not be very significant, but during periods of stringency the
demand for accommodations from the System could conceivably become highly inelastic, particularly in the very short run when
banks may face liquidity or credit demands
(including those from long-valued customers) without having immediate access to
adequate alternative sources of funds. In
such instances, the exclusive use of price as
the allocator of funds at the discount window
could be severely damaging to the long-run
stability of financial institutions.
There may also be occasions when relationships between U.S. rates and those
abroad, or between bank and market rates
or those being paid at other financial institutions, are so delicately poised that Federal
Reserve discount rate changes may have to
be withheld in order to avoid triggering
highly disadvantageous flows of funds. At
such times, the overriding importance of
other relevant national interests involved
may compel the discount mechanism to operate with greater reliance upon its quantitative and administrative controls and less
upon the impersonal criterion of rate.
These limitations should not, however, be
thought to deprecate the role which the discount rate can play under normal circumstances; usually rate can serve as a pervasive,
sensitive, clearly uniform, and flexible control mechanism. But the limitations mentioned demonstrate the impracticality of exclusive reliance on rate. Other controls
—quantity and frequency limitations and,
when necessary, administrative actions—
must be not only available but also in use if
the System is to be sure that discounting


operations do not subvert monetary control
Under the present Regulation A, with the
great bulk of Federal Reserve loans carrying
maturities of 15 days or less, few problems
arise with regard to outstanding loans when
the discount rate is changed. The circumstances would become somewhat different,
however, if a seasonal loan were to be outstanding for as long as 9 months. As an integral part of the proposal for redesign,
therefore, it is recommended that all discount rate changes be made immediately
applicable to all outstanding loans. The suggested provision would eliminate the tendency for banks to overestimate their seasonal needs in order to "lock in" credit in
anticipation of an expected rate increase.
The automatic rate adjustment would also
be helpful in achieving the objectives of monetary policy, since it would avoid allowing
relatively long-term loans to remain outstanding at the earlier rate, thereby increasing the lag in the impact of a policy-motivated rate change. Lastly, without this type
of built-in adjustment, banks whose borrowing begins shortly before a rate decrease
would be unfairly penalized or would be
forced to go through the administratively
burdensome procedure of repaying their
loans and reborrowing at the lower rate.
Discount rates will continue to be established by the Boards of Directors of the

Reserve Banks, subject to review and determination by the Board of Governors. This
method of rate-setting carries with it the
possibility of short-term inter-district differences in the discount rate. Such short-term
differences are not viewed as a problem, and
the proposed redesign contains no special
provisions to prevent them, mainly because the machinery for achieving uniformity, through use of the requirement of approval by the Board of Governors, is available in the event that it is needed. In any
case, it is probably somewhat unrealistic to
contemplate the maintenance of wide interdistrict rate differentials over any period of
time in the highly interdependent economy
of the Nation.
As noted in Section V, emergency credit
to the economy through nonmember institutions should be provided only at a significant
penalty relative to the discount rate. While
the responsibility of the Federal Reserve to
provide lender-of-last-resort credit to the
economy through these institutions is generally recognized, it remains true that the
benefits of membership in the System must
be maintained and member banks should
therefore receive some measure of preferential treatment. This penalty rate might be
thought of as offsetting in part the cost of
maintaining reserves with the System, which
is continuously borne by member banks.

A. Provisions for coordination of
discount administration

The increased reliance on the discount rate
and on quantity and frequency limitations to
regulate borrowing behavior, which constitutes an essential part of the redesign of the
discount mechanism, will permit a clear and
unequivocal communication of these facets

of discounting standards and limitations to
member banks and will thereby help to promote uniformity of window operation among
districts and among banks. However, the retention of a measure of administrative control is seen as necessary if the System is to
accommodate adequately the widely differing needs of individual member banks while

at the same time maintaining the necessary
monetary control. It is intended that such
administrative control be applied in the most
uniform and consistent manner possible in
line with the principle of equal treatment for
banks in equal circumstances. Regulation
and machinery to help insure this objective
are therefore regarded as appropriate.
One effective move in this direction will
be the formalization of a practice already
in existence. Recent years have seen a significant increase in the level and frequency
of communication among the discount officers of the 12 Reserve Banks. These officials now hold an annual conference and
monthly telephone conference calls in addition to the more informal contacts among
individual districts.
These discussions are devoted in large
part to the exchange of information on the
ways in which individual borrowing cases
are being handled. Out of this exchange
administrative guidelines have been developing which can be referred to by discount
officers faced with a new or unusual situation. This development is seen as an evolutionary process, with the character of the
guidelines expected to change somewhat
over time in line with experience and
changes in the surrounding economic climate. However, the need for machinery for
fostering the development of such guidelines
and maintaining them (that is, currently
existing and perhaps stepped-up contacts
among all discount officers) is recognized,
and such further arrangements as are felt
necessary will be implemented as part of the
redesigned discount window.
B. Changes in reserve regulations to
facilitate end-of-period reserve adjustment

The Steeling Committee endorsed the lagged
reserve proposal adopted by the Board


of Governors as an amendment to Regulation D. Under this plan, which will become
effective September 12, 1968, all member
banks have a 1-week reserve accounting
period with required reserves based upon
deposits 2 weeks earlier. Vault cash to be
counted as reserves is also lagged 2 weeks.
Banks are permitted to carry forward to the
next reserve period excess reserves or reserve
deficiencies of up to 2 per cent of required
reserves. This plan, including a number
of other less significant changes, should ease
adjustment problems at the end of reserve
periods and is a move complementary to
the redesign of the discount mechanism fostering a smoother and more effectively functioning member banking system.
C. On-going studies of means of improving
the shiftability of bank assets and liabilities

A possible type of credit accommodation
not provided for in the redesigned window
is long-term credit to meet the needs of
banks servicing perennial credit-deficit areas
or sectors. It was concluded that the solution
to this problem does not properly lie within
the scope of discount-window operations. To
undertake to provide credit for such a purpose would enmesh the System in socioeconomic and political problems beyond its
proper scope and could distort the balance
sheet structure of commercial banking in
some communities by financing the expansion of loan portfolios far beyond the limits
of deposits. More direct and fundamental
answers to the credit-deficit problem are believed to lie in the improvement of secondary
markets for bank assets and liabilities.
The Steering Committee therefore recommends that ad hoc task forces be established
within the Federal Reserve System—possibly
also drawing on the talents of other agencies


and groups—to pursue detailed studies of
the feasibility of providing long-term credit
assistance through some types of marketperfecting actions. It is recognized that extensive work has already been done in this
area, with only limited success, but the Steering Committee nonetheless regards improvement of secondary markets as the most
promising solution to the credit-deficit problem and feels that further investigation can
be fruitful.
These studies will have to recognize and
evaluate the possibility that the development and expansion of such markets may
in itself impose further responsibilities on

the Federal Reserve System in periods of
extreme monetary stringency. As banks are
led to concentrate an increasing portion of
their adjustment efforts in these markets, the
possibilities will increase that conditions in
one or more of them could become so disrupted that it would become necessary to
take action to forestall the developing crisis.
Such action could include making the discount window available to banks to reduce
necessitous sales of these assets, thus alleviating crisis pressures in such markets. Further
consideration of this possibility is contained
in Section V, "Emergency Credit Assistance."

Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102