Adjustment Credit
The term adjustment credit refers to a short-term loan extended by a Federal Reserve Bank to a smaller commercial bank when it needs to maintain its reserve requirements and support short-term lending. The term adjustment credit refers to a short-term loan extended by a Federal Reserve Bank to a smaller commercial bank when it needs to maintain its reserve requirements and support short-term lending. An adjustment credit is a short-term loan extended by a Federal Reserve Bank to a smaller commercial bank when it needs to maintain its reserve requirements. A commercial bank secures an adjustment credit with a promissory note, often using them when interest rates are high, and the money supply is short. An adjustment credit is just one of the options available to commercial banks under the Federal Reserve's Regulation A, which provides guidance and rules about how institutions can borrow from the Fed's discount window.
What Is an Adjustment Credit?
The term adjustment credit refers to a short-term loan extended by a Federal Reserve Bank to a smaller commercial bank when it needs to maintain its reserve requirements and support short-term lending. Adjustment credits are a common form of borrowing between commercial banks and Federal Reserve Banks. A commercial bank secures an adjustment credit with a promissory note, often using them when interest rates are high, and the money supply is short.
How Adjustment Credits Work
A commercial bank's reserve amount — held either in its own vaults or with the closest Federal Reserve Bank — reflects the total amount of deposits held on behalf of its customers. The reserve requirement assures customers that their money will always be available upon request. Reserves protect banks if customers decide to make large withdrawals en masse.
Reserve requirements protect banks if customers decide to make large withdrawals all at once.
When a bank's reserves are low, they can turn to the Federal Reserve to make up the difference through an adjustment credit. An adjustment credit is a type of short-term loan that allows a bank to continue lending to its customers. A commercial bank secures this loan by using a promissory note — a financial instrument that details a written promise by the issuer to pay the lender a definite sum of money. So by using the note, the bank promises to repay the Federal Reserve Bank the amount of money it borrows. Payment can be specified either on-demand or at a set future date, and typically contains all the terms pertaining to the indebtedness, such as the principal amount, interest rate, maturity date and place of issuance, and issuer's signature.
As noted above, commercial banks often use adjustment credits when interest rates are high and the money supply is short. Higher interest rates require larger payouts on customer deposits, while a short supply of money requires additional float to perpetuate bank operations. Adjustment credits are normally granted for very short periods of time — usually overnight. Interest rates for adjustment credits, set by the Fed, are typically lower than the federal funds rate — the rate commercial banks lend to one another.
Special Considerations
An adjustment credit is just one of the options available to commercial banks under the Federal Reserve's Regulation A, which provides guidance and rules about how institutions can borrow from the Fed's discount window. The other two options are:
Related terms:
Bank Reserves
Bank reserves are the cash minimums financial institutions must retain to meet central bank requirements. Read how bank reserves impact the economy. read more
Bank Rate
A bank rate is the interest rate at which a nation's central bank lends money to domestic banks, affecting domestic banks' monetary policy and loans. read more
Commercial Bank & Examples
A commercial bank is a financial institution that accepts deposits, offers checking and savings account services, and makes loans. read more
Credit
Credit is a contractual agreement in which a borrower receives something of value immediately and agrees to pay for it later, usually with interest. read more
Discount Rate
"Discount rate" has two distinct definitions. I can refer to the interest rate that the Federal Reserve charges banks for short-term loans, but it's also used in future cash flow analysis. read more
Discount Window
Discount window is a central bank lending facility meant to help banks manage short-term liquidity needs. read more
Federal Funds
Federal funds are excess reserves that commercial banks deposit at regional Federal Reserve banks which can then be lent to other commercial banks. read more
Federal Funds Rate
The federal funds rate is the target interest rate set by the Fed at which commercial banks borrow and lend their excess reserves to each other overnight. read more
Federal Reserve System (FRS)
The Federal Reserve System is the central bank of the United States and provides the nation with a safe, flexible, and stable financial system. read more
Federal Reserve System (FRS)
The Federal Reserve System, commonly known as the Fed, is the central bank of the U.S., which regulates the U.S. monetary and financial system. read more