August 17, 2007 / 12:44 PM / in 12 years

FACTBOX: What is the Fed's discount window?

WASHINGTON (Reuters) - The Federal Reserve said on Friday it cut by a half point the primary discount rate, which governs direct loans from the central banks to commercial banks.

The primary discount rate is one of the central bank’s monetary policy tools and provides a borrowing safety valve for qualifying institutional borrowers.

The primary discount rate is now 5.75 percent, one-half of a percentage point above the target for the federal funds rate, which is the Fed’s benchmark short-term interest rate.

The discount window was restructured in early 2003 to lift discount rates above the federal funds rate and improve its operation as a policy tool and backup source of funds for banks.

Discount rates are set regularly by the Fed’s 12 regional branches under three separate programs: primary credit, secondary credit and seasonal credit. The move on Friday was unanimously approved by the Fed board.

Each is offered at a different rate, with primary credit usually extended only for very short periods of time and to borrowers in sound financial health.

Financial institutions that don’t qualify for primary credit can request access to secondary credit to meet short-term liquidity needs, or to tackle serious financial problems.

The third category at the discount window is seasonal credit, and is aimed at relatively small institutions experiencing seasonal swings in borrowing needs, like banks in farm communities.

One of the reasons the discount window was restructured in 2003 was to break down the reluctance of institutions to borrow from the Fed by designing the primary credit facility for firms in good health, thus making it a more effective policy tool.

Source: Federal Reserve

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