What is the overnight rate?

The overnight rate is the interest rate charged for loans between financial institutions with a maturity of one business day. In the United States, the most important overnight rate is the effective federal funds rate (EFFR), which represents the volume-weighted median rate on overnight unsecured loans of reserves between banks. Other overnight rates include SOFR (secured, based on Treasury repo transactions) and the overnight bank funding rate (OBFR).

Central banks around the world use overnight rates as their primary tool for implementing monetary policy. The Federal Reserve sets a target range for the federal funds rate and uses several mechanisms to keep the effective rate within that range. These include interest on reserve balances (IORB), which sets a floor by offering banks a guaranteed return on deposits at the Fed, and the overnight reverse repo facility (ON RRP), which provides a similar floor for non-bank institutions like money market funds.

The overnight rate ripples through the entire financial system because it represents the cost of the shortest-term funding available. Banks that need to meet reserve requirements or settle transactions borrow at the overnight rate. Money market funds invest excess cash at rates closely tied to it. Commercial paper rates, repo rates, and other short-term instruments are all priced relative to overnight rates. When the Fed raises its target, all of these rates adjust in tandem.

Monitoring overnight rates is important because disruptions in overnight markets can signal systemic stress. In September 2019, the overnight repo rate spiked to nearly 10%, revealing that reserves had become scarce in parts of the banking system. This episode forced the Fed to intervene with emergency liquidity injections and eventually led to the creation of the standing repo facility. Overnight rate volatility, particularly at quarter-end and year-end when balance sheet constraints bind, provides early warning of potential funding market stress.