Banking in the Ninth

Primary Credit from the Discount Window

Credit Payment Systems - March 2017

Melissa Norwood | Financial Analyst
Stefanie Aschenbrenner | Financial Analyst

Published March 15, 2017  | March 2017 issue

Primary Credit is a key lending program of the Federal Reserve Banks’ discount window. Primary Credit is a convenient source of contingency funding for eligible depository institutions, and extensions to institutions support the orderly operation and liquidity behind domestic financial and payments markets. Nevertheless, we are aware that some institutions are reluctant to borrow from the discount window because of a perceived stigma that can be associated with previous Federal Reserve Bank lending. Specifically, some associate an institution’s discount window usage with a troubled financial condition or poor financial performance. While potentially true of historic and/or other Fed credit programs, in the current case of Primary Credit, the exact opposite is true. The eligibility and use characteristics of the Primary Credit program are designed and administered in ways that are intended to specifically counteract this stigma. This article briefly summarizes the Primary Credit program and provides information for institutions to consider on the benefits of using Primary Credit.

The Federal Reserve System established the Primary Credit program in 2003, largely to provide a funding alternative with minimum administrative burden for financially healthy and adequately capitalized depository institutions. Institutions in unsatisfactory financial condition or with less than adequate capital are not eligible for Primary Credit. This fact alone helps dispense any negative financial condition or performance stigma associated with borrowing under the Fed’s Primary Credit program. Primary Credit extensions are intended as a source of immediate contingency funding for an institution’s unexpected needs. The terms of Primary Credit include the following:

  • The interest rate is set slightly above the federal funds rate.
  • Credit is typically extended overnight.
  • No administrative or additional fees are charged for establishing or using borrowing capacity
  • Sufficient collateral must be pledged.
  • Generally, no explanation or justification is required to obtain Primary Credit.

For financially healthy and adequately capitalized depository institutions, Primary Credit can be a key component of an institution’s liquidity or funding risk management program. Banking supervisors generally encourage banks to consider the Fed’s Primary Credit program as one source of contingency funding appropriate under a risk management program. The Federal Reserve Bank of Minneapolis has noted gradual increases in usage of Primary Credit among Ninth District institutions over the past several calendar quarters without any adverse effect. Increased usage is largely attributable to more institutions operationally testing their processes for borrowing Primary Credit and to gradually declining or normalizing reserve account balances. These trends are expected to continue. Indeed, in an environment where reserves are scarcer than current levels, the Federal Reserve has encouraged depositories to borrow from the discount window and lend to other depositories in cases where short-term funding rates spike. Such lending helps “arbitrage” away temporary movements in short-term funding markets, typically driving down rates to the rate targeted by the Federal Reserve.

As mentioned, it is important to consider that only financially healthy institutions are eligible for Primary Credit extensions and that actual extensions carry a low administrative burden to the borrowing institution. While there are duration limitations on the use of Primary Credit and actual use is subject to public disclosure after a two-year lag, an increasing understanding of eligibility requirements and intended uses has alleviated and will continue to alleviate misconceptions involving depository institutions’ use of the program.

The Federal Reserve’s discount window serves many purposes for depository institutions and contributes to economic and market stability. Ninth District institutions are encouraged to find out more about the Primary Credit program and to potentially consider it as a component of their institution’s risk management tool set. For more information, including how to establish and test Primary Credit discount window access, visit https://www.frbdiscountwindow.org/ or contact discount window staff directly at (877) 837-8815.

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