In the United States, federal funds are overnight borrowings between banks and other entities to maintain their bank reserves at the Federal Reserve. Banks keep reserves at Federal Reserve Banks to meet their reserve requirements and to clear financial transactions. Transactions in the federal funds market enable depository institutions with reserve balances in excess of reserve requirements to lend reserves to institutions with reserve deficiencies. These loans are usually made for one day only, that is, "overnight". The interest rate at which these deals are done is called the federal funds rate. Federal funds are not collateralized; like eurodollars, they are an unsecured interbank loan.
Federal funds transactions by regulated financial institutions neither increase nor decrease total bank reserves. Instead, they redistribute reserves. Before 2008, this meant that otherwise idle funds could yield a return. (Since 2008,the Fed has paid interest on reserves, including excess reserves.) Banks may borrow these funds to avoid an overdraft (that is, the balance going below reserve requirement) of their reserve account, or in order to meet the reserves required to back their deposits. Federal funds are definitive money, meaning that they are available for immediate spending, while checks and many other forms of money must be cleared by banks and typically take several days before becoming available for spending.
Participants in the federal funds market include commercial banks, savings and loan associations, government-sponsored enterprises, branches of foreign banks in the United States, federal agencies, and securities firms. Many relatively small institutions that accumulate reserves in excess of their requirements lend reserves overnight to money center and large regional banks, as well as to foreign banks operating in the United States. Federal agencies also lend idle funds in the federal funds market.
See also
- Arbitrage
- Discount rate
- Federal funds probability
- Opportunity cost
- LIBOR
- Repurchase agreement
References
External links
- Federal Funds - Fedpoints - Federal Reserve Bank of New York
- Instruments of the Money Market: See Chapter 2 - Federal Funds
