What is the Federal Discount Rate?

The Federal Discount Rate is the interest rate that the Federal Reserve charges banks for borrowing money. This is usually done overnight to satisfy reserve requirements on short notice.

It is different than the Federal Funds Rate, which is the rate that banks charge each other. The 12 regional Federal Reserve Banks determine their Federal Discount Rate in board meetings every 14 days. It is the interest that will be charged to member banks to borrow directly from the Fed, which they do at times in order to make sure they have enough capital reserves to satisfy regulations.

Banks will usually be able to get a better rate from each other, if the other banks have money to lend, and this is known as the Federal Funds Rate, even though it is not determined by the Fed — it is only closely correlated to the Discount Rate.

In fact, the Fed does intentionally push the Federal Funds Rate one way or the other through the use of the Discount Rate, influencing the Funds Rate without controlling it. The discount rate tends to be as much as an entire percentage point higher than the Federal Funds Rate.

Loans made by the Federal Reserve Banks are described as going through the Discount Window, and the rates are sometimes called window rates. Banks only use window loans as a last resort.

This is partially because the rates are normally higher, partially because certain approved collateral is required (unlike the Federal Funds marketplace), and partially because there is a stigma attached to using the discount window, and banks fear that other banks will start to think they are financially distressed.

The approved collateral typically fits with the definition of a Lombard loan, where collateral can include securities such as equities or bonds or cash-value life insurance policies (in other countries), all of which have a clear market value and liquidity.

What is the Interbank Rate?
What is the Federal Reserve Bank?