The interest on reserve balances, referred to as IORB in English, is an interest rate control tool implemented by the Federal Reserve on July 29, 2021, replacing the previous interest on required reserves (Interest on Required Reserves, referred to as IORR) and the interest on excess reserves (Interest on Excess Reserves, referred to as IOER). IORB has become the upper limit of the current interest rate corridor set by the Federal Reserve for financial institutions. The lower limit of the interest rate corridor is determined by the overnight reverse repurchase rate. The reserve balance interest rate is the interest rate paid by the Federal Reserve for financial institutions to store their reserves with the Federal Reserve. The Federal Reserve uses this tool to better regulate the liquidity of US dollars in the market. Before 2008, the Federal Reserve did not pay interest on banks’ reserves stored at the Fed. However, during the 2008 subprime mortgage crisis, both the Federal Reserve and the U.S. government realized the importance of sufficient U.S. dollar reserves to provide sufficient liquidity support to the banking system when needed. In order to obtain sufficient U.S. dollar reserves, the U.S. Congress authorized the Federal Reserve in 2008 to pay interest on bank deposits stored at the Federal Reserve, thereby expanding the amount of bank deposits at the Federal Reserve. At the same time, the Federal Reserve can also more conveniently adjust the effective federal funds rate by adjusting the interest rate on reserve balances. The federal funds rate is the main tool used by the Federal Reserve to complete its tasks of controlling prices and promoting employment. Therefore, the reserve balance interest rate has become one of the important means for the Federal Reserve to complete its functions. What is the significance of interest rates on reserve balances? The predecessors of the Interest Rate on Reserve Balances (IORB) are the Interest Rate on Required Reserves (IORR) and the Interest Rate on Excess Reserves (IOER). The purpose of the Federal Reserve setting the reserve interest rate is to better control the currency liquidity in the market, so that the Federal Reserve can implement various monetary control policies more effectively and better complete its functions of controlling prices, increasing employment and regulating forward interest rates. If the Federal Open Market Committee (FOMC) believes the economy is overheating and inflationary pressures are building, the Fed sells government bonds through open market operations (OMOs) while raising the interest rate on reserves to reduce U.S. dollar liquidity because banks have less liquidity to trade with other banks. Similarly, when the FOMC believes that economic growth is too slow or inflationary tightening occurs, the Fed will purchase government bonds through OMO and lower the reserve interest rate to increase US liquidity, because then banks will have excess US dollar liquidity for transactions. The federal funds rate is the most important short-term interest rate that affects other interest rates in economic development, and the reserve balance interest rate is one of the important tools used by the Federal Reserve to regulate the federal funds rate. When the Fed raises the reserve interest rate, banks will be more willing to increase their reserves at the Fed and earn interest, so the amount of dollars circulating in the market will decrease; and when the Fed lowers reserves, banks will reduce the amount of their reserves at the Fed and lend to other institutions, businesses, or individuals, so the amount of dollars circulating in the market will increase. Before the 2008 subprime mortgage crisis, the Fed did not pay interest on banks' reserves stored at the Fed. Beginning on October 6, 2008, the Federal Reserve began to pay interest on reserve balances to banks and depository institutions to better maintain the cash capacity in the Federal Reserve's accounts. By setting the interest rate on reserve balances, the Fed makes it easier to absorb monetary liquidity from the market, and then provide the market with a reasonable increase in liquidity by purchasing Treasury bonds or mortgage-backed securities, rather than simply increasing liquidity within the banking system, because that would lead to excessive currency growth and excessive inflation.
After getting through the crisis, the Fed can better control the level of excess reserves when ending its monetary stimulus policy, avoid severe market fluctuations, and allow the market to transition to a more stable state of normalization. How does the Fed control interest rate ceilings through IORB? The interest rate on reserve balances is the interest rate banks can earn when they deposit money with the Federal Reserve. The federal funds rate is the interest rate that banks can get when they lend money to other banks. Currently, the Fed sets the interest rate on reserve balances at the upper limit of the federal funds rate corridor because: The federal funds rate will be adjusted according to the demand for mutual borrowing between banks. When the demand for mutual borrowing increases, the federal funds rate will increase. On the contrary, if the demand decreases, the federal funds rate will decrease. Therefore, the Federal Reserve will adjust the federal funds rate by adjusting IORB to guide the market's demand for borrowings: If the IORB is raised, banks will borrow money from other banks and then deposit it into the Federal Reserve to earn the interest difference between the IORB and the federal funds rate. As the demand for borrowing from other banks increases, the federal funds rate rises; By lowering the IORB, banks lose the incentive to borrow money from other banks and deposit it with the Fed. As the demand for borrowing from other banks decreases, the federal funds rate will fall; It can be seen from this that currently, IORB is at the upper limit of the interest rate corridor set by the Federal Reserve for the banking industry. How to check the reserve balance interest rate? Since IORB will be implemented on July 29, 2021, only historical data starting from July 29, 2021 can currently be queried. You can check the historical data of IORB through the St Louis Fed. As of December 25, 2024, the IORB interest rate value is 4.40%. Reserve Balance Interest Rate IORB [Source] If users need to check the previous statutory reserve interest rate and excess reserve interest rate, they can also check it on the relevant portal website, but the data update will stop in July 2021. Statutory reserve ratio IORR [Source] Interest rate on excess reserves IOER [Source] How does the interest rate on reserve balances come about? In 2006, Congress authorized the Federal Reserve to pay interest on certain categories of reserve deposits in the Financial Services Regulatory Relief Act, which took effect on October 1, 2011 [source]. However, in 2008, the subprime mortgage crisis in the United States led to the outbreak of a large-scale financial crisis, and the reserve interest rate was implemented in advance. From October 6, 2008, the statutory reserve interest rate (IORR) and the excess reserve interest rate (IOER) were implemented. Therefore, the United States began to provide interest on banks' reserves deposited with the Federal Reserve in 2008. The IORR here is the deposit interest rate that banks can get when they deposit the amount of statutory reserves to the Federal Reserve, and the IOER is the deposit interest rate that banks can get when they deposit the US dollars that exceed their reserves to the Federal Reserve. In the initial stage, the interest rate on statutory reserves is higher than the interest rate on excess reserves. But starting from January 2009, the values of IORR and IOER are basically the same. It should be emphasized here that before March 24, 2020, the Federal Reserve required banks to have a reserve ratio (Reserve Ratio). The reserve ratio is the ratio of the cash deposited by the bank in its vault or the Federal Reserve to all its deposits. However, starting from March 24, 2020, the Federal Reserve lowered the bank reserve ratio to 0. Since there is no reserve requirement, it makes no sense to distinguish between IORR and IOER. Therefore, starting from July 29, 2021, the Federal Reserve will use a unified interest rate on reserve balances (IORB), replacing the previous IORR and IOER. More macroeconomics What is the Federal Reserve Balance Sheet? Explore the Fed’s 24 primary dealers What is the National Financial Conditions Index? Published by the Chicago Fed What is the Buffett indicator? Buffet Indicator What is the U.S. Treasury Volatility Index? Move Index What dollar index? US Dollar Index
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