Fed Policy • Money Markets

1. What Is Interest on Reserve Balances (IORB)?

Interest on Reserve Balances (IORB) is the interest rate that the Federal Reserve pays to commercial depository institutions on the reserve balances they maintain overnight in Federal Reserve master accounts. Enacted under the Financial Services Regulatory Relief Act of 2006 and expedited during the 2008 banking crisis, IORB is the Federal Reserve's primary policy rate for anchoring short-term interest rates.

2. Why IORB Replaced Open Market Operations as the Primary Tool

Under the historical "scarce reserves" framework, the Fed adjusted the federal funds rate by buying and selling Treasury bills to alter reserve balances on the margin. However, multi-trillion dollar Quantitative Easing (QE) programs flooded the banking system with vast excess reserves.

In an environment with multi-trillion dollar excess reserves, standard open market sales could not drain enough liquidity to raise rates. IORB solves this problem by functioning as an administered opportunity cost: a commercial bank has zero economic incentive to lend funds in the private market at a rate below what the risk-free central bank pays directly on reserve deposits.

3. The Mechanics of the IORB-EFFR Spread

In pure textbook economic theory, the Effective Federal Funds Rate (EFFR) should equal IORB. In practice, EFFR trades roughly 5 to 10 basis points below IORB due to market structure constraints:

• Non-Bank Eligibility Gap: Government-Sponsored Enterprises (GSEs such as Fannie Mae, Freddie Mac, and Federal Home Loan Banks) hold cash at the Fed but are statutory non-banks, making them ineligible to earn IORB.
• The Arbitrage Spread: GSEs lend their surplus cash overnight to commercial banks at EFFR. The borrowing banks leave those funds at the Fed overnight, pocketing the spread between EFFR and IORB.
• Balance Sheet & Regulatory Costs: Banks require a positive spread (typically 6–9 bps) to compensate for FDIC insurance assessment fees and leverage ratio constraints (e.g. Supplementary Leverage Ratio — SLR).

4. The IORB & ON RRP Corridor Relationship

To prevent non-bank liquidity from leaking downward and dragging overnight interest rates below the FOMC's target range, the Fed pairs IORB with the Overnight Reverse Repo Facility (ON RRP):

By adjusting IORB and the ON RRP rate in tandem during FOMC meetings, the central bank maintains surgical control over the entire complex of money market rates, including repo (SOFR), Treasury bill yields, and commercial lending benchmarks.

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