The FR 2420 data is used to support the implementation of monetary policy and the analysis of money market conditions. 5  The Board of Governors of the Federal Reserve System is responsible for setting the rate of interest on reserves. Since December 16, 2008, the interest rates on required reserve balances and excess reserve balances have both been ¼ percent, but the rates need not be the same. More information can be found in Regulation D. See http://federalreserve.gov/bankinforeg/reglisting.htm#D. BIS central bankers’ speeches  3  transaction I just described is not riskless. As a result, many lenders limit their risk exposure to any individual bank, reducing the force of competition in the market for funds. 6 In addition, while banks do not need economic capital to conduct this arbitrage, they do face regulatory balance sheet costs from expanding their assets, even in the form of excess reserves, that is, cash. Some of these costs are direct, such as the FDIC fees paid by domestic banks on their liabilities less capital and transactions costs in brokered markets, while others relate to the costs associated with regulatory requirements on capital and liquidity ratios. Even if the market for funds were perfectly competitive, these costs should drive a wedge between IOER and other money market rates. As a result, the IOER rate does not directly establish a firm floor under money market rates, but instead can be thought of as a magnet, with the strength of its pull determined by these balance sheet and competitive frictions.
Similar to IOER for banks, ON RRPs provide a risk-free overnight investment directly to a broad range of bank and non-bank counterparties. By reaching financial institutions that are ineligible to earn IOER, an ON RRP facility widens the universe of counterparties that should generally be unwilling to lend at rates below those available from the Fed. Such a facility could also enhance competition in money markets by offering an alternative safe investment and thus  6  Moreover, competition may be imperfect in some money markets currently, allowing spreads to persist longer than they would if markets were more competitive. For example, much money market activity is over-thecounter, potentially leading to search frictions and bargaining. Anecdotal evidence suggests that lenders typically interact directly with a relatively small number of counterparties, perhaps because a portion of the activity is derived from costly relationship lending. Finally, to limit counterparty credit risk, lenders sometimes seek to diversify their lending and apply concentration limits, which are often binding. 7  As I’ll explain, high-frequency variation in balance sheet costs could induce high-frequency changes in the pull of IOER and, in turn, the spread between the IOER and money market rates. We see this transitory dynamic around financial statement reporting dates. On these dates, balance sheet costs for some banks increase, and the fed funds rate and other money market rates fall relative to the IOER rate.