Why does the Federal Reserve lend money to banks?
The Federal Reserve lends to banks and other depository institutions--so-called "discount window lending"--to address temporary problems they may have in obtaining funding. Those problems can range from "garden variety" issues, such as funding pressures associated with unexpected changes in a bank's loans and deposits, to extraordinary events, such as those that occurred after the September 11, 2001, terrorist attacks or during the financial crisis in 2008 and 2009. In all of these cases, the Federal Reserve provides loans when normal market funding cannot meet banks' funding needs; while the discount window is not intended for ongoing use in normal market conditions, it is available to cover unexpected developments.
To encourage banks to first seek funding from market sources, the Federal Reserve lends at a rate that is higher, and thus more expensive, than the short-term rates that banks could obtain in the market under usual circumstances. To minimize the risk that the Federal Reserve will incur losses from lending, borrowers must pledge collateral, such as loans and securities. Since 1913 when the Federal Reserve was established, it has never lost a cent on its discount window loans to banks.
For more on this topic, see "Lending to depository institutions."