Definition
The term primary credit refers to a source of short-term funding for depository institutions. Primary credit is available to financially sound depository institutions at a rate that is above the target rate for federal funds.
Explanation
When the Federal Reserve System in the United States was first established, lending via the Discount Window was the principal tool of the central banking system. Today, the Discount Window provides funds when a depository institution experiences a short-term liquidity problem. Most depository institutions qualify for primary credit, which provides them with funding at a rate that is 50 basis points (generally) above the Federal Open Market Committee's target rate for federal funds on an overnight basis.
While depository institutions generally avoid borrowing at the Discount Window, since it may be perceived as a sign of distress, some common borrowing situations include:
Money market volatility or arbitrage opportunities
Meeting a short-term liquidity issue arising out of a large, and unexpected, withdrawal
An unexpected surge in the demand for loans
Avoiding an overnight overdraft
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