The Discount Rate: How the Fed Lends to Banks

The Federal Reserve's discount rate is the interest rate charged when the Fed extends short-term loans directly to eligible depository institutions through its discount window. This page covers how that mechanism is structured, what types of credit are available, the scenarios in which banks draw on it, and the institutional rules that govern access. The discount rate sits at the center of the Fed's role as lender of last resort and connects directly to the broader architecture of monetary policy.

Definition and scope

The discount rate is not a single rate but a tiered schedule administered by the 12 Federal Reserve Banks under the authority of the Board of Governors. The Board of Governors must approve each Reserve Bank's proposed rate, a requirement established under the Federal Reserve Act and codified at 12 U.S.C. § 347b. The discount window is available to depository institutions — commercial banks, savings institutions, and credit unions — that hold accounts at a Federal Reserve Bank and meet applicable collateral and eligibility standards.

The rate is distinct from the federal funds rate, which governs overnight lending between private banks in the interbank market. Where the federal funds rate is a target set by the Federal Open Market Committee, the discount rate is an administered rate set by the Reserve Banks with Board approval. The two rates move in the same directional context but serve different institutional functions.

How it works

Access to discount window credit follows a structured process:

1. Eligible institution submits a borrowing request to its regional Federal Reserve Bank, typically through an online portal or direct communication with the Reserve Bank's credit department.
2. Collateral is pledged in advance or at the time of borrowing. Acceptable collateral includes U.S. Treasury securities, agency debt, mortgage-backed securities, and a range of consumer and commercial loans. The Federal Reserve Bank applies haircuts — percentage reductions to the collateral's face value — to manage credit risk.
3. Loan terms are confirmed, including amount, rate type, and maturity. Primary credit loans are typically overnight; secondary credit can extend further with Reserve Bank approval.
4. Funds are credited to the borrowing institution's reserve account at the Federal Reserve Bank, providing immediate liquidity.
5. Repayment occurs at maturity, with interest accruing at the applicable discount rate tier.

The three tiers of discount window credit each carry a different rate:

• Primary credit — the standard facility, available to financially sound institutions at a rate set above the federal funds rate target (historically 50 basis points above the upper bound of the target range, though the specific spread is subject to Board adjustment).
• Secondary credit — available to institutions that do not qualify for primary credit; carries a rate 50 basis points above the primary credit rate (Board of Governors, Federal Reserve System).
• Seasonal credit — designed for smaller depository institutions with recurring seasonal funding needs, such as agricultural lenders; the rate is pegged to an average of market rates.

Common scenarios

Discount window borrowing arises in three broad contexts.

Routine liquidity management — A community bank facing unexpected deposit outflows or a temporary mismatch between assets and liabilities may draw on primary credit overnight rather than selling assets at a loss. This use is operationally normal and carries no regulatory stigma under official policy, though research by economists at the Federal Reserve Bank of New York has documented that institutions historically avoided the window due to perceived reputational risk — a phenomenon known as "discount window stigma."

Stress episodes and systemic events — During the financial crisis of 2008, the Fed broadened eligible collateral and created supplemental facilities to move credit to institutions that could not access private markets. The Term Auction Facility introduced in 2007 was designed partly to reduce stigma by auctioning credit anonymously to groups of banks rather than providing identifiable bilateral loans. The Federal Reserve's response to the 2008 crisis illustrates how the discount window expands in scope during systemic stress.

Seasonal agricultural cycles — Banks serving farming communities often experience predictable funding gaps between planting-season loan disbursements and harvest-period repayments. Seasonal credit, which can extend up to 9 months, covers this structural gap without requiring institutions to maintain excess reserves year-round.

Decision boundaries

The Board of Governors sets discount rates at least every 14 days under the review cycle established by Federal Reserve operating procedures. Rate changes require a formal vote by each Reserve Bank's board of directors followed by Board of Governors approval. This two-step governance structure differentiates discount rate changes from federal funds rate decisions, which are made exclusively by the FOMC.

Three factors define whether a borrowing request is approved or declined:

• Financial condition of the applicant — Primary credit requires the institution to be in "generally sound" financial condition, assessed against CAMELS supervisory ratings maintained by the institution's primary federal regulator.
• Collateral sufficiency — The pledged collateral must cover the loan amount after haircuts. The Fed's collateral margins are published by each Reserve Bank and vary by asset class.
• Absence of continuous use — Extended reliance on primary credit for core funding, as opposed to short-term liquidity needs, triggers scrutiny. Under Federal Reserve Regulation A (12 C.F.R. Part 201), Reserve Banks may decline to extend credit if use is not consistent with the purpose of the facility.

The discount rate mechanism is one component within the larger toolkit described across the Federal Reserve's overview of operations. Changes to the rate signal the Fed's assessment of credit conditions and reinforce or modify the broader stance communicated through interest rate decisions and forward guidance.