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What is the Fed's Discount Window?

The U.S. Federal Reserve Friday it cut by a half point the primary discount rate, which governs direct loans from the Fed to banks.

The primary discount rate provides a borrowing safety valve for qualifying institutional borrowers.

The primary rate is now 5.75 percent, one-half a percentage point above the target for the federal funds rate, which is the Fed's benchmark short-term interest rate and its main tool to influence the economy.

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

The boards of directors of the 12 regional Fed banks can request changes in the discount rate, which then need to be approved by the Fed's board. The action taken on Friday came at the request of the boards of the New York Federal Reserve and the San Francisco Fed banks, and was approved unanimously.

In addition to the primary discount rate, the Fed also lends directly under two other discount window programs: secondary credit and seasonal credit.

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 is seasonal credit, which is aimed at relatively small institutions experiencing seasonal swings in borrowing needs, like banks in farm communities.

In restructuring the discount window program in 2003, Fed officials hoped to break down the reluctance of institutions to borrow from the central bank, and believed the primary credit rate could provide a cap for the fed funds rate in times of financial market stress.

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