The Policy Toolkit: Corridor and Floor Systems, Standing Facilities and Reserve Requirements

What you will learn

• Why the deposit rate, not the refinancing rate, is the ECB's real policy rate today.
• How corridor and floor systems differ, and why the Fed and the ECB now run floors.
• What standing facilities and minimum reserves do.
• How a 25-basis-point move travels to €STR, Euribor and loans.

Explanation

The market side of euro money rates was covered in the bonds course ("Money-market rates, deposits and the ECB deposit rate"). Here we look at the machinery that turns an announced rate into the actual overnight rate.

Reserves and the overnight market

Reserves are the deposits that commercial banks hold at the central bank to settle payments and meet minimum reserve requirements. Banks with too few borrow from banks with too many; the average rate of those loans is the overnight rate: €STR (euro short-term rate) in the euro area, the effective federal funds rate (EFFR) and SOFR (secured overnight financing rate) in the US.

Standing facilities

A standing facility is a window banks use at their own initiative at a pre-announced rate:

• The deposit facility pays interest on reserves parked overnight. ECB: deposit facility rate (DFR). Fed: interest on reserve balances (IORB).
• The lending facility lends overnight against collateral at a penalty rate. ECB: marginal lending facility (MLF). Fed: discount window and Standing Repo Facility.

No bank lends below the deposit rate (it could park the money at the central bank instead), and none borrows above the lending rate: the two rates form the floor and ceiling of a corridor.

Corridor versus floor

In a corridor system reserves are scarce: the central bank supplies just enough through weekly auctions (the ECB's main refinancing operations, MRO) that the overnight rate settles near the middle. The ECB ran this before 2008.

In a floor system reserves are abundant: nobody pays much above the deposit rate, so the overnight rate falls to the floor and stays there. Asset purchases after 2008 pushed the Fed and the ECB into floors. The ECB made this official in March 2024: the DFR steers policy, the MRO is offered with full allotment (banks receive all they bid for against collateral), and since 18 September 2024 the MRO sits only 15 basis points above the DFR, with the MLF a further 25 basis points higher. A review is planned for 2026; check the current spreads.

The Fed calls its version the ample-reserves regime: IORB is the main floor and the overnight reverse repo facility (ON RRP) a sub-floor for money-market funds that cannot earn IORB. Because some lenders (notably the Federal Home Loan Banks) cannot earn IORB, the EFFR trades a few basis points below it. The Fed announces a 25-basis-point target range.

Reserve requirements

The ECB requires 1% of certain short-term deposits as minimum reserves, remunerated at 0% (as of 2026; check the current rule). The Fed set its requirement to 0% in March 2020. Today the price of reserves, not their quantity, controls lending.

From policy rate to the real economy

1. Overnight: €STR follows the DFR; EFFR and SOFR follow IORB.
2. Term money market: Euribor and term SOFR reflect the expected path of overnight rates over the next months, so they move before an anticipated decision.
3. Bank rates: variable loans priced "Euribor + margin" reset at the next fixing; deposit rates adjust more slowly (the deposit beta, the share passed on, is often well below 1). Bond yields follow in lesson 9.

Worked example

Hypothetical example: DFR 2.00%, MRO 2.15%, MLF 2.40%; all figures invented.

Step 1: the floor. A bank has €500 million of excess reserves and is offered 1.95% overnight. The deposit facility pays 2.00%. The 0.05-point difference is worth €500,000,000 × 0.0005 = €250,000 per year, or about €694 per night (÷ 360). No treasurer accepts 1.95%, so market offers rise towards 2.00%. With abundant reserves, that is where €STR settles (a few basis points below in practice, because lenders without access to the facility accept less).

Step 2: a borrower. A business has a €200,000 loan at 3-month Euribor + 1.5%. If the ECB cuts by 25 basis points and Euribor follows, interest falls by €200,000 × 0.0025 = €500 per year from the next fixing date. If the cut was expected, Euribor fell before the announcement and little changed on decision day.

Exclusions: bank fees; Euribor rarely moves exactly one-for-one with the DFR.

Common mistake

Practice activity

On paper (hypothetical): IORB is 4.40%, the ON RRP rate 4.25%, the target range 4.25–4.50%. (a) Where in the range should the effective federal funds rate trade, and why? (b) A money-market fund places $2 billion overnight at the ON RRP rate. What does it earn per night (ACT/360)?

Key takeaways

• Standing facilities create a ceiling and a floor; with abundant reserves the overnight rate sits on the floor.
• The ECB steers through the DFR (MRO 15 bp and MLF 40 bp above it since September 2024); the Fed through IORB and the ON RRP rate inside a 25-basis-point range.
• Minimum reserves (1% at the ECB, 0% at the Fed) do not control lending today.
• Anticipated moves are priced into Euribor and term SOFR before decision day; only surprises move them.

Next step

Next we look at why reserves became abundant: quantitative easing, its channels, and its slow reverse, quantitative tightening.