Definition: The Federal Reserve discount rate is the rate that the Federal Reserve charges banks to borrow at its discount window. It is usually a percentage point above the Fed Funds rate, because the Fed usually wants to discourage excessive borrowing.
Why would banks borrow at the Fed's discount window, anyway? The Federal Reserve also requires that banks have a certain amount of cash on hand each night, known as the reserve requirement. To maintain bank solvency, the Fed does not want banks to loan 100% of their money. However, the Fed realizes that sometimes banks loan out too much that day. Therefore, it allows them to borrow from the discount window to make sure they have enough for their reserve requirement.
Examples:
On August 17, 2007, the Federal Reserve made the unusual decision to lower the discount rate to restore liquidity in the overnight borrowing markets.
