Federal Reserve Discount Rate
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The Federal Reserve discount rate is the rate that the Fed charges banks when they need financial resources to continue operating. When banks need a short-term loan they go to the Federal Discount Window to do so. There are four discount programs called primary credit, secondary credit, seasonal credit, and emergency credit. Different rates are usually charged in accordance with the type of program extended to financial institutions. The Federal Reserve Bank is the bank that serves the U.S. government. "For the LORD thy God blesses thee, as He promised thee: and thou shall lend unto many nations, but thou shall not borrow; and thou shall reign over many nations, but they shall not reign over thee" (Deuteronomy 15:6). The Federal Reserve discount rate is used when an institution comes to the discount window for secured short-term loans. The rate adjusts periodically to reflect the changes that happen in market conditions and is usually higher than the funds rate to discourage institutions from borrowing excessively.
The Fed System was created to ensure that the banking system in the United States remains strong and stable. The Fed regulates banks to make sure that they are in compliance with banking guidelines set by the Fed. The Federal Reserve discount rate is there for institutions that fall below the required reserves. The Fed makes sure that the banks are in compliance with operating procedures and sometimes even go on-site to do a thorough examination. Rules are put in place to protect customers and the financial system as a whole. Examinations of member banks are also done off-site as well. Some sources claim that member banks who are not upholding operating policies will have to make adjustments to remain a member of the Fed. Each member bank receives dividends that are paid annually to compensate them for reserves that do not normally earn interest.
There are 12 Fed banks and 25 branches in operation. In order to be a member of the Fed bank the member banks must purchase so much stock from the Reserve System. The stock can never be sold or traded. This provides the Fed with security for loans granted to member banks. Every bank has a Board of Directors consisting of nine members who makes the big decisions and oversees all operations. The member banks provide the main bank with economic information and help to maintain monetary policies and make decisions that need to be made to uphold those policies. The Federal Reserve discount rate must be approved by the Board of Governors.
Banks often borrow from the discount window because they have loaned out too much money in a day's period and do not have enough left in their reserve. The Federal Reserve discount rate is the rate of interest that a bank is charged when they borrow the money to replenish their reserve. The institutions that are members of the Fed must keep so much money available at all times in order to remain compliant with guidelines set up by the Fed. Short-term loans may be necessary from time to time in order to keep the set amount of money replenished. However, these short-term loans usually cost the banks a higher interest rate than the current funds rate. This is set up this way to discourage the borrowing of money unnecessarily.
Primary credit is a type of credit that is extended to member banks for up to 90 days. Credit can be extended a few weeks if the institution is financially sound. Primary credit is often extended to institutions without providing reasons. The Federal Reserve discount rate is set to help those institutions who can not obtain temporary funds any other way than through the Fed. Some sources say that the Fed looks closely at an institution that makes a habit of borrowing frequently even when the bank can qualify for primary credit. The extensive of credit is dependent upon discount rates that are normally reestablished at least every two weeks. This includes programs for primary, secondary, and seasonal credit.
Secondary credit requires the borrower to provide information about financial condition and the reasons for borrowing funds and then must be approved by the Fed before credit is extended. When a bank does not qualify for primary credit then they are looked at closely to see if they qualify for secondary credit. The Federal Reserve discount rate is higher for secondary credit compared to primary. Credit for any type of program can only be granted to institutions that are members of the Fed and maintain reserves based upon the regulations set forth by the Fed bank. The Fed bank has a unique set up where there is an internal check so that one part of the system can not go awry.
Seasonal credit is set up for institutions that need help in managing seasonal swings in loans and deposits. The Federal Reserve discount rate for seasonal credit is a floating rate that is based upon market conditions. An institution asking for seasonal credit must become eligible by establishing a seasonal standing with the Fed bank. Institutions applying are subject to careful review before being granted seasonal standing. Besides seasonal credit an institution can apply for emergency credit if there are circumstances warranting such. There is normally a serious emergency and the bank desiring credit must not be able to acquire credit from other sources. In order to get an approval for emergency credit at least five members of the Board of Governors must vote affirmative.
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