Federal funds
Encyclopedia
- This article is about funds maintained by the U.S. Federal Reserve. For the funds provided by the U.S. government in terms of aid and assistance, see Federal aid.
In the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, federal funds are overnight borrowings by bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
s to maintain their bank reserves
Bank reserves
Bank reserves are banks' holdings of deposits in accounts with their central bank , plus currency that is physically held in the bank's vault . The central banks of some nations set minimum reserve requirements...
at the Federal Reserve. Banks keep reserves at Federal Reserve Banks to meet their reserve requirement
Reserve requirement
The reserve requirement is a central bank regulation that sets the minimum reserves each commercial bank must hold of customer deposits and notes...
s and to clear financial transactions. Transactions in the federal funds market enable depository institutions
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
with reserve balances in excess of reserve requirements
Excess reserves
In banking, excess reserves are bank reserves in excess of the reserve requirement set by a central bank. They are reserves of cash more than the required amounts. Holding excess reserves is generally considered costly and uneconomical as no interest is earned on the excess amount...
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 rate
In the United States, the federal funds rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis. Institutions with surplus balances in their accounts lend...
. Federal funds are not collateralized
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...
; like eurodollars, they are an unsecured interbank loan
Interbank lending market
The interbank lending market is a market in which banks extend loans to one another for a specified term. Most interbank loans are for maturities of one week or less, the majority being overnight. Such loans are made at the interbank rate...
.
Federal funds transactions neither increase nor decrease total bank reserves. Instead, they redistribute reserves and enable otherwise idle funds to yield a return. 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 bank
Commercial bank
After the implementation of the Glass–Steagall Act, the U.S. Congress required that banks engage only in banking activities, whereas investment banks were limited to capital market activities. As the two no longer have to be under separate ownership under U.S...
s, savings and loan association
Savings and loan association
A savings and loan association , also known as a thrift, is a financial institution that specializes in accepting savings deposits and making mortgage and other loans...
s, 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
- Repurchase agreementRepurchase agreementA repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively...
- Federal aid, which is commonly referred to as federal funds.
- compare and contrast with Discount RateDiscount rateThe discount rate can mean*an interest rate a central bank charges depository institutions that borrow reserves from it, for example for the use of the Federal Reserve's discount window....
- Federal Funds RateFederal funds rateIn the United States, the federal funds rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis. Institutions with surplus balances in their accounts lend...
- Fed Funds ProbabilityFed Funds ProbabilityFederal funds probability is the probability of actions taken by the Federal Reserve System of the United States at upcoming Federal Open Market Committee meetings. At every meeting of the FOMC, its members decide whether to increase, decrease, or leave the Federal funds rate unchanged after...
- LIBOR