The term “LOMBARD” comes from Lombards, people who conquered Italy 6c. and settled in the northern region that became known as Lombardy. Rich cities in north Italy – Lombardy – were the birthplace of modern banking, and many of their inhabitants became notable in Middle Ages throughout Western Europe as bankers and money-lenders, also pawn-brokers; London’s Lombard Street (1598) originally was occupied by “Lombard” bankers.
Lombard credit is the granting of credit to banks against pledged items, mostly in the form of securities. The pledged items must be readily marketable. Lending is via central banks, in particular the securities ‘eligible for collateral’ which are registered on lists; as a general rule, the Lombard rate (interest rate) is more or less one per cent above the discount rate. The pledging of securities means that the credit institutions have the opportunity of acquiring money in the short term from central banks.
One prominent role of Lombard credit is in use by the Federal Reserve System of the United States of America. Traditionally, the discount rate, or the rate charged by the Fed to member banks in need of funds (ostensibly to maintain the required reserve ratio), was lower than the target federal funds rate, or the rate charged among banks for the same type of overnight credit. This meant that banks could borrow from the Central Bank at a lower rate than they could from each other, which somewhat conflicts with the Central Bank’s role as a “lender of last resort”. A discount rate lower than the rate typically charged by another bank opened the possibility of arbitrage and thus required extra scrutiny of potential borrowers. The Federal Reserve Board of the United States switched to a so-called “Lombard facility,” in which the discount rate is actually higher than the targeted federal funds rate, thus creating an economic incentive for banks to look elsewhere before asking to borrow from the Fed.
The practice of Lombard credit is still commonly used in central banking, where central banks lend against marketable securities, such as government bonds. Modern repo (repurchase-sale transactions) are also forms of Lombard lending: one bank sells marketable securities to another (at a discount), with an agreement to repurchase the securities (typically at par) in a fixed period of time. Although the legal documentation of the transaction is that of a sale and subsequent repurchase, the substance of the transaction is a secured loan (and under most accounting standards, will be treated as a loan). Pawn shops in many countries and languages are often still referred to as Lombards.