Federal Funds

What are Federal Funds?

Generally referred to as fed funds, federal funds are the excess reserves that financial institutions and commercial banks deposit at their regional Federal Reserve Banks. To other Market participants, who have insufficient cash, these funds can be lent for them to meet their reserve and lending requirements.

Basically, these are unsecured loans and are available at low-interest rates, which is known as overnight rate or federal funds rate.

Explaining Federal Funds

Fed funds are helpful enough for commercial banks when it comes to meeting daily or periodic reserve requirements, which is the amount that banks need to maintain at the regional Federal Reserve.

Generally, these reserve requirements are dependent upon the customer deposit’s volume that every Bank has. Secondary, or excess, reserves are the amounts that a bank or a financial institute holds in excess of what is needed by internal controls, creditors, or regulators.

For commercial banks, these excess reserves are evaluated against standard reserve required amounts that the central banking authorities set. These necessary reserve rations set the minimum liquid deposits that should be reserved with a bank.

In case there is an amount that goes above this minimum amount, this would be regarded as the excess. The Federal Reserve Bank is responsible for setting the target Range or rate for the fed funds rate, and it gets altered periodically on the Basis of monetary as well as Economic Conditions.

Understanding the Fed Funds Rates

The Federal Reserve makes use of Open Market operations to Handle the money supply in the Economy and alter short-term interest rates whenever required. This simply means that the Fed sells or buys some government bills and Bonds that it issues; thus, increasing or decreasing the supply of money and lowering or raising the short-term interest rates accordingly.

Basically, Open Market Operations are handled and regulated by the Federal Reserve Bank of New York. The fed funds rate or federal funds rate is one of the essential interest rates for the economy as it has the power to impact broad economic conditions in the entire country, including employment, growth, and Inflation.

This federal fund rate is set in US dollars and can be charged on overnight loans. In a way, federal funds are closely related to short-term interest rates in the extensive market; thus, these transactions can directly affect the LIBOR and Eurodollar rates as well.