FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.

posted on 10 August 2015

History Of Discount Window Stigma

by Liberty Street Economics

-- this port authored by Olivier Armantier, Helene Lee, and Asani Sarkar

In August 2007, at the onset of the recent financial crisis, the Federal Reserve encouraged banks to borrow from the discount window (DW) but few did so. This lack of DW borrowing has been widely attributed to stigma - concerns that, if discount borrowing were detected, depositors, creditors, and analysts could interpret it as a sign of financial weakness. In this post, we review the history of the DW up until 2003, when the current DW regime was established, and argue that some past policies may have inadvertently contributed to a reluctance to borrow from the DW that persists to this day.

The Discount Window's Tradition against Borrowing

The Fed was established in 1913 to create an elastic money supply that would expand to meet high demand for liquidity during times of stress and contract once conditions improved. At that time, there were no open market operations (the buying and selling of government securities in the open market) to conduct monetary policy. Instead, the Fed adjusted the money supply by lending directly to banks through the DW. During these initial years, the DW was used extensively, and there appears to have been no mention of stigma attached to DW borrowing.

From the late 1920s, the DW gradually fell into disuse as the Fed began to take a dim view of DW borrowing and adopted a stance against the practice. The Fed observed that banks were becoming habitual borrowers from the DW, and it was concerned that an overreliance on DW borrowings would weaken banks and make them more prone to failure. Moreover, the Fed had switched to open market operations as its primary tool for conducting monetary policy. Accordingly, it viewed the DW as playing a more subordinate role by providing limited amounts of short-term credit to banks, to meet emergency needs, for example.

Although it discouraged DW borrowing, the Fed generally kept the DW rate below the market rate, in part because the Fed lacked independence from the Treasury and was obliged to keep the DW rate below the market rate to help the federal government finance its deficits at low rates. The Treasury - Federal Reserve Accord of 1951 freed the Fed from pressure from the Treasury, but the Fed continued to maintain the DW rate below the market rate despite recommendations to the contrary. It did so because it believed that banks that legitimately needed DW funds should not face a punitive rate. Thus, between 1914 and 2003, the DW rate was generally below the market rate on banks' primary sources for short-term funding (in other words, the commercial paper rate before 1954 and the federal funds rate since 1954; see chart below).

History of Discount Window Stigma

Given that DW borrowing was cheaper than borrowing on the market, the Fed aimed to limit DW borrowings in other ways, including "direct pressure" on banks not to borrow from the DW. Between the late 1920s and the 1980s, the Fed adopted and amended numerous restrictions on DW borrowing. Whenever DW borrowings increased, the Fed tightened the restrictions to suppress borrowing. For example, in the 1950s, when DW borrowings rose, the Fed issued detailed restrictions distinguishing between "appropriate" and "inappropriate" borrowings; borrowing to fund regular business activities was considered inappropriate. In 1973, the Fed added the requirement that, prior to accessing the DW, banks must demonstrate that they have exhausted private sources of funding. In the early 1980s, following another period of elevated DW borrowings, the Fed levied a surcharge on frequent borrowings by large banks to augment the administrative restrictions.

These policies appeared to have been effective, as DW borrowings (adjusted for the size of the banking sector) remained low after the 1920s, except for occasional minor spikes (see chart below). Thus, the policy of below-market lending along with specific constraints to limit borrowing characterized the Fed's DW for most of the twentieth century.

History of Discount Window Stigma

What Policies May Have Contributed to Discount Window Stigma?

Throughout the Fed's history, several policies may have contributed to the stigma associated with DW borrowing. The Fed's pressure on borrowers to limit DW borrowing likely created the perception among banks that DW use should be avoided. In particular, the requirements that a borrower had to satisfy the Fed that it had a legitimate reason to borrow from the DWand that it had exhausted private sources of funding likely contributed to DW stigma. Indeed, these requirements may have led market participants to presume that if a bank was borrowing from the DW, it must be in trouble, even if, in fact, the bank was borrowing to address a temporary funding shortfall or to meet reserve requirements.

Another important factor that may have contributed to DW stigma was that, initially, the Fed lacked an official stance on DW lending to failing or insolvent institutions. Indeed, until the FDIC Improvement Act of 1991, which restricted Fed lending to undercapitalized banks, the Fed occasionally lent to banks that turned out to be insolvent. A watershed event was the experience of Continental Illinois National Bank and Trust, one of the largest banks to become insolvent and illiquid, which borrowed $3.6 billion under adjustment credit on May 11, 1984. When the DW loan became public, it further increased stigma in a way that administrative restrictions alone were not able to achieve. The incident helped reinforce a perceived link between recourse to the DW and financial problems, which made solvent banks reluctant to access the DW for fear that they might be considered insolvent.

The 2003 Discount Window Reform

To address concerns about DW stigma, the Fed fundamentally changed its DW policy in 2003, when it established the Primary Credit Facility (PCF). Only financially strong and well-capitalized banks are allowed to borrow at the PCF. The rate charged is a penalty rate above the target (range) for the fed funds rate (rather than a subsidized rate, as in the past), as seen in the DW rate chart. The PCF is a "no questions asked" facility - in other words, the Fed no longer asks banks whether they have exhausted all other sources of funding and it has no restrictions on the purpose of the loan. The Secondary Credit Facility was also created at this time, as a facility for weaker institutions that do not satisfy the criteria for Primary Credit - reinforcing the idea that borrowing from the PCF does not necessarily reflect a solvency problem.

The post-reform DW is more consistent with Walter Bagehot's classical principles that central banks should lend freely to illiquid but solvent institutions against good collateral but at a penalty over the "normal" market rate. By lending freely, central banks create an expectation that they will be available to provide as much liquidity as is needed during a crisis and alleviate the high demand for liquidity that triggers most crises. By charging a penalty rate, they ensure that banks borrow as a last resort.

The 2003 reforms, however, do not appear to have removed the perception of DW stigma, as shown in "Discount Window Stigma during the 2007-2008 Financial Crisis," and DW borrowing generally remained sparse (see the second chart, above). A plausible explanation for the persistence of DW stigma is that the old policies left lasting perceptions of the DW, which, among other factors, may have dissuaded banks from readily using it to this day.


The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.


About the Authors

Olivier ArmantierOlivier Armantier is an assistant vice president in the Federal Reserve Bank of New York's Research and Statistics Group.

Helene LeeHelene Lee is a senior associate in the Bank's Markets Group.

Asani SarkarAsani Sarkar is an assistant vice president in the Research and Statistics Group.

Click here for Historical News Post Listing

Make a Comment

Econintersect wants your comments, data and opinion on the articles posted.  As the internet is a "war zone" of trolls, hackers and spammers - Econintersect must balance its defences against ease of commenting.  We have joined with Livefyre to manage our comment streams.

To comment, using Livefyre just click the "Sign In" button at the top-left corner of the comment box below. You can create a commenting account using your favorite social network such as Twitter, Facebook, Google+, LinkedIn or Open ID - or open a Livefyre account using your email address.

You can also comment using Facebook directly using he comment block below.

Econintersect Contributors


Print this page or create a PDF file of this page
Print Friendly and PDF

The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.

Take a look at what is going on inside of
Main Home
Analysis Blog
Comments on Feyerabend’s ‘Against Method’, Part II
Comments on Feyerabend’s ‘Against Method’, Part III
News Blog
Rail Week Ending 15 October 2016 Paints A Negative Economic View
What Is The New Normal For U.S. Growth?
Affordable Care Act And Its Effect On Part-Time Employment
The Speed Of Filling Jobs Is Declining
First Working Eggs Made From Stem Cells Points To Fertility Breakthrough
Infographic Of The Day: Mega Machines
Online Platforms Double Down On TV Programming
A History Of Mars Missions
How Tesla Out Innovates Traditional Carmakers
Schiaparelli's Descent To Mars In Real Time
September 2016 Existing Home Sales Still Not Excellent
September 2016 Leading Economic Index Improves Indicating Moderate Growth Ahead.
October 2016 Philly Fed Manufacturing Survey Declines But Remains In Expansion.
Investing Blog
Options Early Assignment - Should You Worry?
The 401k Plan Manager 17 October 2016
Opinion Blog
Prop. 51 Versus A State-Owned Bank: How California Can Save $10 Billion On A $9 Billion Loan
Obama's Middle East Policy Has Been A Complete Failure - Or Has It?
Precious Metals Blog
How Will The Election Outcome Impact Precious Metals?
Live Markets
20Oct2016 Market Close: US Indexes End Flat After Choppy Session, Nigeria Slashes Oil Prices, Crude Prices Continue To Slip, Bullish Investors Not So Bullish Anymore
Amazon Books & More

.... and keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Middle East / Africa
USA Government

Crowdfunding ....



Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day


Asia / Pacific
Middle East / Africa
USA Government

RSS Feeds / Social Media

Combined Econintersect Feed

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution



  Top Economics Site Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2016 Econintersect LLC - all rights reserved