SRC Insights: First Quarter 2003

Federal Reserve Simplifies Access to the Discount Window

by Vish P. Viswanathan, Vice President and Discount Officer

On January 9, 2003, two new discount window facilities, the primary and secondary credit programs, replaced the old adjustment and extended credit programs.¹ The below-market rate on adjustment credit has been eliminated and all discount window loans are now offered at rates above usually prevailing market rates for overnight interbank loans. The change to an above-market rate and accompanying changes in eligibility requirements make possible a substantial reduction in administration of discount window lending. Under the new program, requests for overnight loans by financially sound depository institutions normally will be approved on a "no-questions-asked" basis. Collateral requirements are unchanged; as before, every discount window loan must be secured to the satisfaction of the Reserve Bank extending the loan.² The seasonal credit program also continues unchanged.

The changes to the discount window credit programs do not imply any change in the stance of monetary policy as measured by the Federal Open Market Committee's (FOMC) target for the federal funds rate. Rather, the revisions aim to make the discount window a more effective monetary policy tool by making discount window credit more readily available and increasing depository institutions' willingness to borrow from the window when money markets tighten.

Primary Credit Program
Primary credit will serve as the principal safety valve to ensure adequate liquidity in the banking system. Primary credit is available as a backup source of funds to depository institutions deemed to be in generally sound financial condition by Federal Reserve Banks. Eligibility is determined largely by the institution's supervisory examination rating and capital status; supplementary information such as public debt ratings and other market information and periodic input from bank supervisors/examiners may also be considered. Generally, institutions with a composite CAMELS rating of 1, 2, or 3 that are at least adequately capitalized are eligible for primary credit, unless supplementary information indicates their condition is not generally sound.³

Primary credit will be extended on a very short-term basis, typically overnight, to eligible institutions on a "no-questions-asked" basis. Primary credit may also be extended for up to a few weeks to small institutions in sound financial condition that cannot obtain temporary funds in the market at reasonable terms. Institutions need not seek alternative sources of funds before requesting occasional short-term advances from the primary credit program. There is no prohibition against using primary credit to fund sales of federal funds. Except in unusual circumstances, depository institutions will not be questioned about the reason for borrowing primary credit.

Initially, the primary credit rate was set at 2.25 percent, which is 100 basis points above the FOMC's target for the federal funds rate. In recent years, the rate for adjustment credit usually was 50 basis points below the targeted federal funds rate. Reserve Banks' Boards of Directors will establish the primary credit rate at least every two weeks through the same process they used to set the adjustment credit rate, subject to Board of Governors review and determination. Given the above-market pricing of primary and secondary credit, the Federal Reserve anticipates that depository institutions will not find it advantageous to rely on the discount window as a regular source of funding.

With discount rates above usually prevailing market levels, there will be less need for Reserve Banks to administer discount window loans—especially primary credit loans to financially healthy institutions. The Federal Reserve expects that reduced administration will help eliminate the "stigma"—real or perceived—associated with discount window borrowing. With a "no-questions-asked" approach and no restrictions on the use of funds obtained through the primary credit program, the Federal Reserve expects that financially sound institutions will use the discount window as a backup source of funds more readily than in the past. In particular, institutions should be more willing to use the window when money markets tighten, thereby limiting the volatility of the federal funds rate. In other words, the primary credit rate will facilitate the implementation of monetary policy by creating a "cap" and limiting temporary upward "spikes" in the federal funds rate.

Secondary Credit Program
Depository institutions that are ineligible for primary credit—including some weaker institutions that were eligible for adjustment credit—may be able to obtain discount window credit through the secondary credit program. The secondary credit rate was initially set at 2.75 percent, which is 50 basis points above the primary credit rate, and will have a higher level of Reserve Bank administration and oversight than primary credit.

Secondary credit will be extended to institutions primarily to assist in their timely return to a reliance on market funding. Secondary credit may also be extended to assist in the orderly resolution of a troubled institution. Section 201.3(d) in the revised Regulation A provides that an institution cannot receive secondary credit as the medium or agent of another depository institution except with the permission of the Federal Reserve Bank extending credit. In other words, the Federal Reserve expects the borrower of secondary credit to use the funds to help resolve its own financial difficulties.

Communication, Contact, and Other Information
The Federal Reserve Bank of Philadelphia sent a letter summarizing the new discount window programs to each Third District depository institution in early December 2002. Institutions that have discount window borrowing agreements with the FRB of Philadelphia were informed about their eligibility for the primary or secondary credit program. Should the eligibility of an institution change, discount window staff will notify the institution immediately. Institutions that have a borrowing agreement with the Federal Reserve Bank of Philadelphia should use the recently established toll-free number 1-800-372-2011 when calling the Federal Reserve Bank to request a discount window loan.

Federal Reserve staff have begun to hold informational sessions with bank supervisors to explain the new discount window programs. In the opinion of the Federal Reserve, supervisors should view occasional use of primary credit as appropriate and unexceptional.

The discount window website contains additional information about the new lending programs, including the Board's press release, which provides more detail about the new programs, the revised Regulation A, a PowerPoint presentation that summarizes the new programs, and responses to frequently asked questions (FAQs). This System website is accessible at www.frbdiscountwindow.org External Link .

Third District institutions should feel free to contact Vish Viswanathan, Vice President and Discount Officer at (215) 574-6403 or Gail Todd, Manager at (215) 574-3886 with any questions about the new discount window lending programs. Depository institutions that do not currently have borrowing agreements on file with the Federal Reserve may want to contact their Reserve Bank to discuss their eligibility to use the discount window, collateral requirements, and other administrative matters.

Primary vs. Secondary Credit at a Glance
Feature	Primary Credit	Secondary Credit
Rate	100 basis points above the FOMC's target for the federal funds rate, or 2.25% on Jan. 9, 2003.	Primary credit rate plus 50 basis points, or 2.75% on Jan. 9, 2003
Term	Short-term, usually overnight, but can also be extended—ordinarily to very small institutions—for up to a few weeks if such credit cannot be otherwise obtained in the market on reasonable terms.	Short-term, usually overnight. Can be extended for a longer term if such credit would facilitate a timely return to reliance on market funding or an orderly resolution of a failing institution, subject to statutory requirements (FDICIA restrictions).
Eligibility	Depository institutions in generally sound financial condition; generally same as eligibility for daylight credit.	Depository institutions that do not qualify for primary credit.
Use	Generally no restrictions. May be used to fund sales of federal funds.	As a backup source of funding on a very short-term basis or to facilitate an orderly resolution of serious financial difficulties.
Administration	Ordinarily no questions asked.	Reserve Banks will collect information necessary to confirm that borrowing is consistent with regulatory requirements.

¹ The Board of Governors approved these and related technical changes by revising Regulation A, Extensions of Credit by Federal Reserve Banks, on October 31, 2002.
² Federal Reserve Banks accept a wide range of assets as collateral to secure the discount window loan. See the article by Kimberly R. Caruso (O'Grady), "A Behind the Scenes Look at How the Fed Values Collateral ," in the Fourth Quarter 2001 issue of SRC Insights.
³ A similar approach using the SOSA, ROCA, and combined ROCA ratings determines foreign banking organizations' eligibility. CRIS ratings are used for credit unions.

The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.

SRC Insights: First Quarter 2003

Federal Reserve Simplifies Access to the Discount Window

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