Brian Madigan

Indeed, one of the important practical difficulties that confronted the Federal Reserve early in the crisis--and one that appears not to have been anticipated by Bagehot--was the unwillingness of many banks to draw discount window credit because of concerns about stigma.
That unwillingness threatened to undermine the effectiveness of central bank action to combat the crisis. And it was an important motivation behind the decision of the Federal Reserve to establish the Term Auction Facility (TAF) as a means of providing a large volume of term funding to banks through an auction mechanism. The Federal Reserve expected that providing funds through an auction, in which no individual institution can have any assurance of winning funds and where settlement takes place with a lag, would have much less stigma than a standing facility.

[P]ricing the facilities at a penalty rate has the added virtue of building an "exit strategy" into the structure of the programs. In pricing the PDCF, the Federal Reserve followed Bagehot's instruction by setting the interest rate on PDCF credit at the primary credit rate charged to depository institutions.
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Actually, the pricing of a collateralized loan is multidimensional, and terms other than the interest rate are relevant. In particular, the terms on which collateral for a discount window loan is taken constitute an important additional dimension, and the haircut applied to the collateral is one of the most salient aspects. In establishing haircuts for the PDCF, the Federal Reserve sought to provide financing on terms that were less onerous than could be obtained in the markets during the crisis but also less attractive than those available in the markets in more routine circumstances. Thus, the haircuts set on the primary dealer facilities represented a generalization of the dictum to "lend at a high rate." This generalization has been applied to the Federal Reserve's other liquidity facilities as well. The fact that usage of the Federal Reserve's liquidity facilities has declined markedly--in several cases to zero--as market conditions have improved suggests that the Federal Reserve has been successful in pricing these programs at terms that represent penalties in more normal circumstances.

[S]everal factors potentially impeded the Federal Reserve's ability to lend to such entities. For example, representatives of the money fund industry advised the Federal Reserve that money funds would be unwilling to borrow, partly because investors would recognize that leverage would amplify the effects of any fund losses on remaining shareholders and intensify their incentive to run. Indeed, the Federal Reserve Board approved the establishment of a Direct Money Market Mutual Fund Lending Facility but left it on the shelf after being informed that money funds would be unwilling to use it.¹⁰

Despite Bagehot's advice to lend broadly, practicability requires that central banks not lend to all firms, or even all financial institutions, either in routine circumstances or in a crisis. Rather, central banks generally need to establish eligibility for their facilities using some sharply defined criteria--for example, a banking charter, designation as a primary dealer, and so on--in order to avoid an untenable situation in which it may appear that individual firms are arbitrarily allowed or denied access. But because firms are heterogeneous, central banks also have to accept that, as a practical matter, any set of potential borrowers defined on the basis of institutional features will comprise firms with a range of financial characteristics, so that what is a penalty rate for one firm may not be for another.