The discount window is a lending facility that allows eligible depository institutions to borrow short-term funds from the Federal Reserve at a discount rate. Banks borrow from the discount window when they need to meet short-term liquidity needs, such as unexpected deposit outflows or when they are unable to obtain funding from other sources.
The discount rate is typically higher than the federal funds rate, which is the interest rate that banks charge each other for overnight loans. Borrowing from the discount window can be seen as a last resort for banks, as it may signal that they are experiencing financial difficulties.
The discount window is distinct from the reverse repo program, which is a tool used by the Fed to absorb excess cash from the financial system. In a reverse repo transaction, the Federal Reserve sells securities from its portfolio to a counterparty, typically a bank or other financial institution, in exchange for cash. The reverse repo rate is the interest rate paid by the Federal Reserve to the counterparty for the use of the cash. Reverse repo transactions are typically used to manage short-term interest rates and to prevent the federal funds rate from falling too low.
