The Basics of Discount Window
For the country’s economy to stay strong, its financial institutions should remain stable. Banks should be consistent in serving their customers and businesses have to make sure they can achieve their goal for improvement or at least stability. When there’s instability in different financial institutions, it will have drastic effects on the country’s economic setting since money becomes unstable. It could be even said that without a stable financial institution, the country could have a very difficult time recovering from the economic chaos. This is the reason why the government has to make sure that different financial institutions are stable.
Stability through Discount Window
When a bank, lender or any financial entity in USA experiences problem with funding, they can seek assistance from the Federal Reserve. Assistance on funding problems is available from the Federal Reserve through their “Discount Window” department. The name came from a dedicated window where bank representatives visit in case they need assistance in funding. The US government through Federal Reserve is the only country that offers “Discount Window” for their banks. Almost every country offers this type of service through the country’s central bank. This is a method for every government to ensure that their financial institution is stable.
The main feature of discount windows is that banks and lenders should be able to enjoy short term loans from the central bank with discounted rate. This is often seen as a short term remedy so that the financial entity can quickly get back on track. Problems in liquidity can easily happen especially when the bank opens itself to extended transactions wherein more funds are requested instead of released. To keep the financial entity on track, they can ask for additional assistance from the government so that they can provide the expected funds.
Eligibility to Participate in Discount Window Program
Not every form of financial institution can immediately seek assistance from the central government through discount window. While specific rules are different in every country on who can participate in the program, the common ground for countries with discount window program is the availability of reserve funds. A financial entity could enjoy the benefits of the discount window program if they have created reserves that they can access anytime. Banks could qualify for this type of assistance if they have enough reserves required by the government. The amount required as reserves varies per country but this is the basic requirement to enjoy the services of discount window.
Aside from qualifications, it is also a common norm for the government to observe an application process. This will help the government particularly the Central Bank to have a thorough review of the banks capability on handling the finances of their depositors. This is also a way to prevent fraudulent transactions with the Central Bank.
Some countries have notable additional requirements for the Discount Window program. A good example is England’s central bank which is the Bank of England or BoE. The BoE requires CRD or Cash Ratio Deposit for banks and other financial institutions who would like to participate in the program. CRD is basically a deposit made to the Bank of England. The interest earned through this deposit is not given to the banks but directed to the BoE for the purpose of maintaining manpower and services to the central bank. In order to qualify for CRD, the financial entity should show no less than £500 million of eligible liabilities. The amount required for the bank is determined by the BoE.
The Cash Ratio Deposit is a brand new scheme developed by BoE. This was developed in response to the recent economic problem experienced by almost every country in Europe.
Requirement for Collateral
The government through the central bank doesn’t just give out short term loans to financial entities even if they already proven that they have reserves or complied with the required Cash Ratio Deposit. Collateral is still required to financial institutions before any loan could be granted. More often than not, the collateral is the determining factor on how much credit will be granted. Additional terms such as payment scheme are also heavily influenced by the available collateral.
The collateral accepted by the government Central Bank is often the loans granted by the bank to their depositors and clients. This is not just limited to basic loans but also to loans granted to corporations and small businesses. Discount Window collateral can also include the corporate bonds.
Granting Discount Window Services to Non-Reserve Entities
The US Federal Reserve through its Discount Window program can also offer their services to financial entities that are not required to hold any reserve. Groups such as corporate credit institutions are not required to hold any reserves since their existence is basically on administrative assistance to different companies. By default, they cannot access any of the services offered by Discount Window. However, financial entities that are not required to hold any reserve could still enjoy the benefits of Discount Window. The only requirement is that they voluntarily create reserves so that they could have some back-up fund which is practically the biggest determining factor for a financial entity to enjoy Discount Window.
It should be noted that Discount Window is a small branch of the country’s central bank since they are just there to provide aid for financial institutions that requires immediate funding. However, their role in maintaining the economic setting is big since they ensure that every transaction for financial companies goes through. This stability indirectly influences the country’s stability economically and politically.