cost and restricting the availability of credit to some types of borrowers. By reducing funding costs and thus providing depository institutions with easier access to capital markets, the cuts in required reserve ratios put depository institutions in a better position to extend credit. reserve requirement ratios have not been changed since the early 1990s, the level of reserve requirements and required reserve balances has fallen considerably since then because of the widespread implementation of retail sweep programs by depository institutions. Under such a program, a depository institution sweeps amounts above a predetermined level from a depositor s checking account into a special-purpose money market deposit account created for the depositor. In this way, the depository institution shifts funds from an account that is subject to reserve requirements to one that is not and therefore reduces its reserve requirement. With no change in its vault cash holdings, the depository institution can lower its required reserve balance, on which it earns no interest, and invest the funds formerly held at the Federal Reserve in interest-earning assets. Discount Window Federal Reserve s lending at the discount window serves two primary functions. It complements open market operations in achieving the target federal funds rate by making Federal Reserve balances available to depository institutions when the supply of balances falls short of demand. It also serves as a backup source of liquidity for individual depository institutions. the volume of discount window borrowing is relatively small, it plays an important role in containing upward pressures on the federal funds rate. If a depository institution faces an unexpectedly low balance in its account at the Federal Reserve, either because the total supply of balances has fallen short of demand or because it failed to receive an expected transfer of funds from a counterparty, it can borrow at the discount window. This extension of credit increases the supply of Federal Reserve balances and helps to limit any upward pressure on the federal funds rate. At times when the normal functioning of financial markets is disrupted-for example after operational problems, a natural disaster, or a terrorist attack-the discount window can become the principal channel for supplying balances to depository institutions. discount window can also, at times, serve as a useful tool for promoting financial stability by providing temporary funding to depository institutions that are having significant financial difficulties. If the institution s sudden collapse were likely to have severe adverse effects on the financial system, an extension of central bank credit could be desirable because it would address the liquidity strains and permit the institution to make a transition to sounder footing. Discount window credit can als...
