The term discount window refers to the process of going to the Federal Reserve to borrow money on a short-term basis. The discount window is one of the three tools the Federal Reserve can use to reach their monetary policy objectives.
Back in 1913 when the Federal Reserve System was established, the discount window was the primary mechanism for conducting central banking operations. The term is a reference to the long-gone practice of a commercial bank representative visiting a reserve teller window to borrow money. Today, open market operations is the primary tool used by the Federal Reserve to achieve their monetary policy objectives. The discount window now serves as a fallback option when a depository institution needs an extension of credit to meet their reserve requirement.
Generally, financial institutions are reluctant to borrow at the discount window since it will be seen by the marketplace as a sign of a liquidity problem. The discount rate is the rate of interest charged for short-term loans made by the twelve Reserve Banks to commercial banks at the discount window. There are three different discount lending programs:
During a credit or liquidity crisis, the Federal Reserve's Board of Governors can authorize a fourth category of lending known as emergency credit. This credit facility can only be offered when a participant is unable to secure credit from other banking institutions. Loans under this program need the approval of at least five of the seven members of the Board of Governors.