Secondary Credit

Definition

The term secondary credit refers to a source of short-term funding for depository institutions that do not qualify for primary credit. Secondary credit requires a higher level of administration and is available at a rate that is above the target rate for primary credit.

Explanation

When the Federal Reserve System in the United States was first established, lending via the Discount Window was the principal tool of the central banking system. Today, the Discount Window provides funds when a depository institution is experiencing a short-term liquidity problem. Most depository institutions qualify for primary credit; however, those institutions that do not qualify may be able to obtain secondary credit. The rate of interest on secondary credit loans is 100 basis points (generally) above the Federal Open Market Committee's target for fed funds.

Generally, depository institutions will avoid borrowing at the Discount Window, since it may be perceived as a sign of distress. Secondary credit functions to help distressed financial institutions in need of short-term credit to eventually return to more traditional funding sources. It also requires a higher level of Reserve Bank administration since some loans may be subject to frequency limits. Unlike primary credit loans, which are provided without explanation, financial institutions will need to confirm with the Reserve Bank the funding need is consistent with the objectives of the Discount Window program. Secondary credit loans are typically overnight, but they can be extended if the funds help the struggling depository institution to return to more traditional funding sources.

Acceptable circumstances under which secondary credit is provided include:

  • Inability to access funding from more traditional sources
  • Money market volatility
  • Meeting the needs of a short-term liquidity problem
  • To mitigate an overnight draft

Secondary credit should not be sought to take advantage of an arbitrage opportunity or to enhance the financial institution's balance sheet.

Related Terms

Primary Dealers Credit Facilityprimary creditprimary dealernonrecourse loan, recourse loan