Discount window

A discount window is a collateralised loan facility offered to banks by the central bank in order to ensure the liquidity of banks.

The central bank specifies a range of securities that it will accept as collateral, and lends against this at rates that reflect both the security and its current interest rates.

Although a discount window can be used as a way of influencing interest rates, it is not usually used this way, as open market operations are more effective. Like open market operations, the discount window is an intervention in the money markets.

In almost all cases, central banks run a discount window as a way of providing temporary liquidity to fundamentally sound banks that have a temporary shortage of cash. It is not intended to be a mechanism for propping up weak or insolvent banks. That is done on a case by case basis under normal conditions, or by special mechanisms introduced to deal with systemic crises.

Because the purpose of a discount window is to provide short term cash to any fundamentally sound bank, central banks usually accept a wide range of collateral. The Federal Reserve's discount window accepts a wide range of collateral. The Bank of England's discount window is newer, having been introduced in response to the credit crunch. It accepts a range of securities, but the range of acceptable collateral is narrower than the Federal Reserve's.

Copyright Graeme Pietersz © 2005-2020