The encyclopedia · Finance & Accounting · Financial decision · 2002–2003
The Fed priced its bailout window above market to make banks use it
In 2003 the Fed replaced subsidized, rationed discount loans with on-demand primary credit priced above market, ending both the subsidy and the stigma.
Federal Reserve Board
the move
Through the 1990s the Federal Reserve's discount window lent only reluctantly: adjustment credit was priced below market and rationed by loan officers, so borrowing signaled weakness and banks avoided it even when they needed cash.
On October 31, 2002 the Board approved a final rule replacing adjustment credit with primary credit, a backup facility open on demand to depository institutions in generally sound condition, priced 100 basis points above the federal funds target. The above-market price removed the incentive to borrow for profit, and eligibility rules removed the need for case-by-case monitoring.
The new rates took effect January 9, 2003 at 2.25 percent for primary and 2.75 percent for secondary credit. Because the rate sat above the funds target, the window became a genuine cap on short-term money-market rates instead of a rationed privilege nobody dared to touch.
why it works
- An above-market price eliminated the arbitrage that made rationing necessary.
- Sound banks qualified by default, so borrowing lost its stigma.
- The penalty rate doubles as a cap: funds rates cannot climb far above it.
- Less administration made the window usable in a genuine emergency.
what transfers
A free but rationed safety net gets stigmatized and unused. Price it above market and open it to everyone sound: the price rations, the stigma dies, and the facility works when needed.
what came after
The primary credit framework anchored Fed crisis lending for two decades: the 2007 Term Auction Facility and 2008 programs were layered on top of it, and the 2023 Bank Term Funding Program was again an on-demand, collateral-backed facility. The 2003 reform became the textbook model for removing stigma from lender-of-last-resort tools.
references
- Final amendments to Regulation A (Extensions of Credit by Federal Reserve Banks)
- Primary and secondary credit rates established
- The New Discount Window
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