Definition: The Federal Reserve can loan money to banks at the discount rate to make sure they can meet the reserve requirement when they close each night. This tool is called the Fed's use of credit, or discount window. Since 1980, any bank, including foreign ones, can borrow at the Fed's discount window.
The borrowing banks must post collateral to the Fed in return for the loan. Such collateral includes: U.S. Treasury securities, state and local government securities, AAA mortgages, consumer loans, and commercial loans. In 1999, the Federal Reserve also accepted investment-grade CD's and AAA-rated mortgage-backed securities.
The Fed only changes this tool in an emergency. For example, during the Y2K scare and again after 9/11, the Fed loosened their constraints on lending to make sure banks had plenty of money to loan. Most recently, the Fed used the discount window to pump extra liquidity into the market during the banking liquidity crisis.
Examples:
The Fed prefers that banks try to get overnight loans from each other, and use the discount window only as last resort.
