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Recent Developments in Discount Window Policy

1994; Board of Governors of the Federal Reserve System; Volume: 80; Issue: 11 Linguagem: Inglês

1944-8910

James A. Clouse,

Housing Market and Economics

Underlying trends in the depository sector along with changes in federal legislation have had important ramifications in recent years for the discount window, the Federal Reserve’s lending facility. The periods of stress and consolidation in the depository sector during the 1980s and 1990s led to the active involvement of the discount window in many failing-bank situations. Indeed, the scope of problems in the banking industry and the extent of discount window lending to troubled institutions were greater than in any period since the Great Depression. In addition, changes became evident during the 1980s in the willingness of healthy institutions to turn to the discount window. Many banks apparently became more reluctant to turn to the window for fear of provoking market concerns about their financial condition. The greater reluctance to borrow weakened the historical relationship between discount window borrowing and the spread of the federal funds rate over the discount rate. This weakening, in turn, impaired the effectiveness of the discount window in tempering unexpected pressure in the reserve market and reduced the Federal Reserve’s emphasis on borrowed reserves in the day-to-day management of the reserve market. Perhaps the most notable legislation affecting the discount window has been the Depository Institutions Deregulation and Monetary Control Act of 1980, which dramatically expanded the universe of depository institutions eligible to borrow at the discount window. As a result, the Federal Reserve assumed greater direct responsibility for responding to the liquidity needs of all depositories. Another important legislative change arose in response to the large number of bank failures in the 1980s and the associated depletion of the insurance funds of the Federal Deposit Insurance Corporation (FDIC). The legislation, the Federal Deposit Insurance Corporation Improvement Act of 1991, contained provisions intended to discourage Federal Reserve lending to depositories that do not meet minimum capital standards. Although these provisions do not prohibit the Federal Reserve from lending to such institutions, they specify that the Federal Reserve will incur a limited liability to the FDIC for lending that extends beyond certain time periods and that results in increased losses to the FDIC’s insurance funds.