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What is the Federal Discount Rate?
The federal discount rate is the interest rate charged by the Federal Reserve to commercial banks and other depository institutions for short-term loans obtained directly from a Federal Reserve Bank.
Definition
Federal Discount Rate refers to the rate at which eligible financial institutions can borrow funds from the Federal Reserve’s discount window, serving as a tool for managing liquidity and financial stability.
Key Takeaways
- Charged on loans from the Federal Reserve to banks.
- Provides liquidity support to financial institutions.
- Set by regional Federal Reserve Banks and approved by the Board of Governors.
- Acts as a backstop to market-based funding.
Understanding the Federal Discount Rate
When banks face short-term funding shortages, they can borrow directly from the Federal Reserve through the discount window. The interest rate applied to these loans is the federal discount rate.
Unlike the federal funds rate, which is market-based, the discount rate is an administered rate. It is typically set above the federal funds target range to encourage banks to seek market funding first, using the discount window as a last resort.
Adjustments to the discount rate signal changes in monetary policy stance and the Federal Reserve’s approach to financial system liquidity.
Importance in Business or Economics
- Supports banking system stability during stress.
- Influences short-term interest rate conditions.
- Acts as a lender-of-last-resort mechanism.
- Signals confidence and liquidity conditions in financial markets.
Types or Variations
- Primary Credit Rate – For financially sound institutions.
- Secondary Credit Rate – For institutions under financial stress.
- Seasonal Credit Rate – For banks with predictable seasonal funding needs.
Related Terms
- Federal Reserve
- Federal Funds Rate
- Discount Window
- Monetary Policy
Sources and Further Reading
- Investopedia — Discount Rate
- Federal Reserve — Discount Window and Rates
- Federal Reserve Bank of St. Louis (FRED) — Interest Rate Data
Quick Reference
- Rate charged on central bank loans to banks
- Liquidity backstop tool
- Supports financial stability
Frequently Asked Questions (FAQs)
How is the discount rate different from the federal funds rate?
The discount rate applies to loans from the Fed, while the federal funds rate applies to interbank lending.
Who sets the federal discount rate?
Regional Federal Reserve Banks set it, subject to approval by the Board of Governors.
When do banks use the discount window?
Primarily during periods of liquidity stress or funding shortages.
