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In Finance, what is a Discount Window?

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  • Written By: H. Bliss
  • Edited By: W. Everett
  • Last Modified Date: 25 June 2018
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A discount window is a United States policy that allows an institution to borrow money from the central bank if they meet the eligibility requirements. The interest rate at which discount window loans are given is called the discount rate. The name "discount window" came from the name of the window to which banks would send tellers from other banks who sought to borrow money. Borrowing periods for discount window loans are short and rarely last longer than a day. The discount window policy is designed to improve bank stability by allowing them a short-term loan during financial emergencies.

These short-term loans are assigned a different interest rate than the prime rate and the federal funds rate. The prime rate is the assigned low-interest threshold given to a consumer who requests a loan. Prime rates are given to the customers with the highest credit ratings because they are deemed a lower financial risk. The federal funds rate is the rate of interest for banks that borrow money from other banks via the Federal Reserve, usually to meet the reserve requirements. The discount rate is usually much lower than the prime rate, but slightly higher than the federal funds rate.

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Borrowing money from this program involves meeting several conditions and requirements set by the Federal Reserve. Banks and institutions that are eligible for a loan under the discount window program include those that have the appropriate reserve deposits held in the Federal Reserve. Borrowing from the discount window usually requires that the borrowing institution show acceptable collateral, which can come in the form of investments such as asset-backed securities or corporate bonds. It is up to the Federal Reserve to decide what types of collateral are suitable for borrowers.

Types of credit offered under the discount window policy include primary credit, secondary credit, seasonal credit, and emergency credit. Primary credit is given to the most reliable financial institutions and offers greater freedom than borrowing under secondary credit, under which the Federal Reserve places restrictions on the reason for the short-term loan. Seasonal credit is given to banks with seasonally fluctuating patronage, such as banks located in cities with heavy traffic from tourists. Emergency credit is given by a vote of the board of governors to individuals or organizations whose continued debt will affect the economy in a negative way, and they are given only if the individual or organization cannot find funding anywhere else.

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