What it is:
A bank or other institution uses the key rate to determine the interest rate on debt. In the United States, there are two key rates: the discount rate and rate.
How it works (Example):
To understand key rates, it is important to understand that banks derive deposits in .from making . When lending generates for banks, they are motivated to lend as much of their as possible. This is a problem when a large number of depositors suddenly want to withdraw their . To prevent the panic that would naturally occur in this situation, the Federal Reserve maintains a fractional reserve banking system, which requires banks to keep a certain percentage of their
The Federal Reserve Discount Rate
When a bank is unable to meet the reserve requirement, it can borrow those from another bank or directly from the Federal Reserve. If it borrows from another bank, it can get a ; borrowing from the Federal Reserve involves borrowing from 's "Discount Window" at the Discount Rate. The loans are unsecured and are for very short periods (typically overnight).
When a bank is unable to meet the reserve requirement, it can get a Fed Federal Funds loans are usually made through who specialize in such transactions, or they are made directly between the banks themselves..
Why it Matters:
Accordingly, the Federal Reserve can trigger a change in the Federal Funds rate by changing the discount rate. This is why the discount rate and the Federal Funds rate are closely correlated key rates.