Federal Discount Rate

What is the federal discount rate?

The federal discount rate is the rate of interest paid by financial institutions to borrow overnight reserve funds from the Federal Reserve's lending facility, likewise called the discount window. This is separate from the federal funds rate, the interest rate banks charge each other for overnight reserve funds.

More profound definition

The Federal Reserve requires banks and other financial institutions to hold a certain amount of money in reserves toward the finish of every business day to guarantee customers can access their funds and to safeguard against bank disappointments. This is alluded to as the reserve requirement. The reserve requirement is roughly 10 percent of the deposits made at a financial institution. For instance, in the event that a bank has deposits of $100,000,000, the bank's overnight reserve requirement would be generally $10,000,000.
In the event that a bank is short on reserves toward the finish of the business day, they must borrow funds to meet the reserve requirement. Banks commonly borrow extra overnight funds from one another, yet on the off chance that for reasons unknown a bank can't borrow from different institutions, it must borrow from the Federal Reserve's discount window.
There are three types of discount rates: primary, secondary, and seasonal. Most banks borrow at the primary rate, which is a short-term loan for stable institutions. Banks in a troublesome financial condition are expected to borrow at the secondary rate. The seasonal rate is principally for more modest, community-centered banks that have fluctuating necessities throughout the year. These banks might serve college networks with a seasonal convergence of understudies or a resort community with seasonal changes in population.
The Federal Open Market Committee (FOMC) meets eight times every year and sets the federal funds rate, contingent upon the necessities of the economy. The Board of Governors of the Federal Reserve sets discount rates that are in accordance with the federal funds rate.
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Federal discount rate model

Speculation bank Pierce and Pierce has seen several of its energy sector bargains turn sour in the continuous oil price collapse. These advancements have drained capital from the firm and made it trying to meet its reserve requirements. Besides, an emerging financial crisis is starting to impact the United States financial sector, and Pierce and Pierce finds that it can't borrow funds at a reasonable rate from one more bank to meet its overnight reserve requirements. These troublesome conditions would compel the firm to borrow from the Federal Reserve's discount window.
This happens when the Federal Reserve raises interest rates.

Features

• The federal discount rate is the interest rate the Federal Reserve (Fed) charges banks to borrow funds from a Federal Reserve bank.
• The Fed discount rate is set by the Fed's board of governors, and can be adjusted up or down as a tool of monetary policy.
• Lending at the discount rate is part of the Fed's function as a lender of last resort, and is one of the Fed's primary monetary policy tools.