Overnight Reverse Repurchase Agreement Facility: What Is It?
Overnight Reverse Repurchase Agreement Facility (ON RRP Facility) is a monetary policy tool used by the Federal Reserve to manage the federal funds rate. This facility was introduced in 2013, and it allows eligible financial institutions to lend funds to the Federal Reserve temporarily. The ON RRP Facility is a type of reverse repurchase agreement (RRP) in which the Federal Reserve borrows funds overnight from eligible counterparties in exchange for Treasury securities.
The ON RRP Facility is used by the Federal Reserve to absorb excess liquidity from the financial system. The Federal Reserve sets a minimum bid rate, which is the interest rate it is willing to pay to borrow funds overnight from eligible counterparties. The eligible counterparties include primary dealers, government-sponsored enterprises, and banks.
The ON RRP Facility is an effective tool for the Federal Reserve to control the federal funds rate, which is the interest rate at which banks lend and borrow funds from one another. The federal funds rate plays a very important role in the US economy as it affects borrowing costs for businesses and individuals.
The ON RRP Facility is used to prevent the federal funds rate from falling too low. When the federal funds rate falls too low, banks will tend to hold excess reserves, which can cause inflation and other economic problems. As a result, when the Federal Reserve borrows funds through the ON RRP Facility, it absorbs excess liquidity from the financial system and increases the federal funds rate.
The ON RRP Facility provides eligible counterparties with a safe and secure investment opportunity. The Federal Reserve offers Treasury securities as collateral, so eligible counterparties have the assurance that their investment is backed by the US government. However, the ON RRP Facility is not a source of profit for eligible counterparties. The Federal Reserve sets a minimum bid rate, which is typically below market rates, to prevent eligible counterparties from profiting from the facility.
In conclusion, the Overnight Reverse Repurchase Agreement Facility is an important monetary policy tool used by the Federal Reserve to manage the federal funds rate. It is a type of reverse repurchase agreement that allows eligible counterparties to lend funds overnight to the Federal Reserve in exchange for Treasury securities. The ON RRP Facility is used to absorb excess liquidity from the financial system and prevent the federal funds rate from falling too low. Eligible counterparties have the assurance that their investment is safe and secure, but the facility is not a source of profit for them.