Or, caps could be imposed on either an aggregate or per counterparty basis in order to limit total usage. The amount of funds invested in the facility is likely to be sensitive to the spread between the posted interest rate and comparable money market rates and the level of caps placed on usage. The narrower the spread to comparable money market rates, the greater the participation is likely to be. In our ongoing tests with this facility, the New York Desk has varied the RRP rate from 1 to 5 basis points and the cap on usage by counterparty has gradually been increased to its current level of $ billion. As expected, narrower spreads to comparable money market rates and larger caps have led to greater usage. Although the testing process is still ongoing, early results suggest that the overnight RRP facility will set a floor under money market rates. Treasury repo rates have generally traded no more than a basis point or two below the overnight RRP rate. 2 2 Thus, the early evidence suggests that this facility would help strengthen our control over money market rates. Two issues with the overnight reverse repo rate warrant careful consideration. The first is how big a footprint the facility should have in terms of volume.
Money market mutual funds and other providers of short-term financing could rapidly shift funds into the facility away from assets such as commercial paper that support the private sector. In contrast, in the current regime, when financial crises lead to flows into less risky assets, their interest rates fall, limiting the appetite for these less risky assets. Consequently, under a full allotment setup, runs could be larger and these runs could  2  6  The floor has been more solid since the testing was extended in January for a full year. In part, this is likely because the extension allowed market participants to plan ahead knowing that they could rely on the facility. Raising the caps has also been a factor in solidifying the floor. BIS central bankers’ speeches  exacerbate the fall in the prices of riskier assets. Note that the risk here is how quickly financial flows could reverse from one day to the next, not the average level of take-up of the facility over time. Fortunately, this risk seems relatively easy to address. One could design the facility to prevent rapid inflows during times of financial stress. This could be done by building in circuit breakers such as caps on overall usage of the facility. The circuit breakers would not affect the amount of take-up during normal times or prevent take-up from rising at moderate rates. Instead, they would be in place to limit the pace and magnitude of inflows during times of stress.