What is the discount window?

The discount window is the Federal Reserve's standing lending facility through which eligible depository institutions can borrow reserves directly from their regional Federal Reserve Bank. The primary credit rate, the interest rate charged on discount window loans, is set above the target federal funds rate (currently 50 basis points above the top of the target range), making it a penalty rate that banks should only access when they cannot obtain funds more cheaply in the open market.

The discount window serves as the Fed's lender of last resort, ensuring that solvent banks can always access liquidity even when interbank markets are frozen or malfunctioning. During normal times, discount window borrowing is minimal because banks can obtain cheaper funding in the federal funds market or repo market. During crises, the discount window becomes essential for preventing liquidity shortages from cascading into solvency crises.

The persistent challenge with the discount window is "stigma": the perception that a bank borrowing from the discount window must be in financial trouble. This stigma deters banks from using the facility even when doing so would be economically rational, because they fear that other market participants will interpret the borrowing as a sign of distress and pull back on lending to them. The Fed has taken steps to reduce stigma, including making discount window loans easier to obtain and encouraging pre-positioning of collateral.

Discount window borrowing spiked during the March 2023 banking crisis following the failures of Silicon Valley Bank and Signature Bank. Banks rushed to the window both for actual liquidity needs and as a precautionary buffer. The Fed also created the Bank Term Funding Program (BTFP), a temporary emergency facility that lent against bank-held Treasuries at par value, specifically to address the unrealized-loss problem that had triggered SVB's collapse. Monitoring discount window borrowing on the Fed's H.4.1 weekly release provides a real-time gauge of banking system stress.