Standing Facilities and Interbank Borrowing: Evidence from the Federal Reserve’s New Discount Window
Standing facilities are designed to place an upper bound on the rates at which financial
institutions lend to one another overnight, reducing the volatility of the overnight interest rate,
typically the rate targeted by central banks. However, improper design of the facility might
decrease a bank’s incentive to participate actively in the interbank market. Thus, the mere
availability of central bank provided credit may lead to its use being more than what would be
expected based on the characteristics of the interbank market. By contrast, however, banks may
perceive a stigma from using such facilities, and thus borrow less than what one might expect,
thereby reducing the facilities’ effectiveness at reducing interest rate volatility. We develop a
model demonstrating these two alternative implications of a standing facility. Empirical
predictions of the model are then tested using data from the Federal Reserve’s new primary
credit facility and the US federal funds market. A comparison of data from before and after
recent changes to the discount window suggests continued reluctance to borrow from the Fed.