Federal funds sold are short-term loans one bank makes to another out of the reserve balances it keeps at the Federal Reserve. From the lender’s point of view, the bank “sells” reserves it does not need for the day; the borrower records the mirror side as “federal funds purchased.” The loans are typically unsecured, usually mature overnight, and settle instantly through the Fed’s wire system. The interest rate on each deal is negotiated privately, and the volume-weighted median of all such rates is the effective federal funds rate.
The Reserves Behind the Loan
Every commercial bank, savings institution, and credit union that qualifies as a depository institution maintains a balance in an account at one of the twelve regional Federal Reserve Banks. Those balances are federal funds. They function like a checking account the bank uses to settle payments with other banks, including check clearing and wire transfers, and because they are immediately available they are the most liquid asset a bank holds.
Reserve requirements were reduced to zero percent effective March 26, 2020, so banks are no longer legally required to hold a set percentage of deposits at the Fed.1Board of Governors of the Federal Reserve System. Reserve Requirements They still keep substantial balances there to settle daily payments, meet unexpected withdrawals, and earn the interest the Fed now pays on reserve balances.
The federal funds market is where banks with more reserves than they need lend to banks running short. Daily volume typically runs around $100 billion to $110 billion.2Federal Reserve Bank of St. Louis. Effective Federal Funds Volume (EFFRVOL)
How the Transaction Works
A bank with excess reserves for the day can lend them out rather than let them sit earning only the Fed’s administered rate. The lending bank instructs the Federal Reserve to move funds from its reserve account into the borrower’s reserve account. The next business day, the borrower returns the principal plus interest. Settlement is nearly instantaneous through the Fed’s electronic system.
Most of these loans carry no collateral.3Board of Governors of the Federal Reserve System. Federal Reserve Supervisory Manual – Section 4005.1 Federal Funds The credit risk is manageable because the standard maturity is overnight and both sides are regulated depository institutions. The rate on each transaction is set between the two parties and reflects how much supply and demand exist for reserves across the system at that moment. When reserves are plentiful, lenders compete for borrowers and rates fall; when reserves are scarce, borrowers bid rates up.
Who Lends and Who Borrows
The market is not limited to commercial banks lending to each other. Savings institutions and credit unions participate, and the modern market is dominated on the lending side by Federal Home Loan Banks, which account for over 90 percent of federal funds lending.4Board of Governors of the Federal Reserve System. Bankers Banks and Their Role in the Federal Funds Market
The reason is structural. Federal Home Loan Banks hold balances at the Fed but are not eligible to earn the interest rate on reserve balances that commercial banks receive. So they lend their excess balances at rates below what banks could earn from the Fed, which still beats zero. Banks on the borrowing side profit from the spread between what they pay the Federal Home Loan Bank and what they earn on those reserves through the IORB rate. That arbitrage drives much of the daily trading volume. Other government-sponsored enterprises appear mainly as lenders too; the borrowing side is almost exclusively domestic depository institutions with Fed accounts.
How Federal Funds Sold Appear on a Bank’s Books
For the lending bank, federal funds sold sit on the balance sheet as a short-term asset representing principal plus accrued interest. Because the loan matures overnight, the bank expects to collect within 24 hours. The borrower carries the mirror entry as a short-term liability called federal funds purchased.
On the Consolidated Reports of Condition and Income that banks file each quarter, federal funds sold are reported on Schedule RC, line 3.a.5Federal Financial Institutions Examination Council. Instructions for Preparation of Consolidated Reports of Condition and Income A bank consistently reporting large volumes on that line is signaling that it holds more reserves than it needs for its own lending and settlement activity.
Connection to the Federal Funds Rate
The Federal Open Market Committee does not dictate the rate banks charge each other on these overnight loans. It sets a target range. As of early 2026 that range is 3.50 to 3.75 percent.6Board of Governors of the Federal Reserve System. The Fed Explained The effective federal funds rate reported in the news is the volume-weighted median of all overnight federal funds transactions on a given day.7Board of Governors of the Federal Reserve System. The Recent Evolution of the Federal Funds Market The Fed uses two administered rates to keep that market rate inside the target range.
The Interest Rate on Reserve Balances
The interest rate on reserve balances, or IORB, is the rate the Fed pays on balances that eligible institutions hold at Federal Reserve Banks.8Federal Reserve Board. Interest on Reserve Balances Frequently Asked Questions As of late 2025 it stands at 3.65 percent.9Federal Reserve Board. Interest on Reserve Balances IORB acts as a soft ceiling: a bank with excess reserves has little reason to lend them in the federal funds market for less than what the Fed will pay risk-free. In practice, the effective federal funds rate sits just below IORB because Federal Home Loan Banks cannot earn IORB and are willing to lend for less.4Board of Governors of the Federal Reserve System. Bankers Banks and Their Role in the Federal Funds Market
The Overnight Reverse Repo Facility
At the other end, the Fed’s overnight reverse repurchase agreement facility puts a floor under the rate. Money market funds and other eligible counterparties can deposit cash at the Fed overnight in exchange for Treasury securities at a set rate. When overnight market rates threaten to drop below the target range, the facility absorbs the excess cash that would otherwise push rates down further.10Federal Reserve Bank of New York. Repo and Reverse Repo Agreements Together, IORB and the ON RRP facility bracket the effective federal funds rate.
Why the Rate Reaches Beyond Banking
Changes in the target range ripple outward quickly. The prime rate, which most banks set at three percentage points above the upper bound of the target range, moves almost immediately. Credit card rates, adjustable-rate mortgages, home equity lines, and business loans move with it. The volume and pricing of federal funds sold transactions are, in that sense, a real-time gauge of conditions that flow through to borrowing costs for consumers and businesses.
Federal Funds Sold Versus Repurchase Agreements
The repo market and the federal funds market are sometimes confused because both involve short-term borrowing between financial institutions, often overnight. The core difference is collateral. Federal funds transactions are typically unsecured; repurchase agreements are secured loans backed by high-quality collateral, usually Treasury securities.11Board of Governors of the Federal Reserve System. Financial Stability Report – November 2019 Because repos carry collateral, they involve a broader set of participants, including securities dealers and money market funds that would never engage in unsecured lending. The federal funds market is more narrowly limited to depository institutions and government-sponsored enterprises with Fed accounts.
For a bank treasurer choosing where to park overnight cash, the tradeoff is straightforward. Repos offer collateral protection but slightly lower yields. Federal funds sold carry more credit exposure but earn a bit more, and the mechanics are simpler since no securities change hands.
Credit Risk if the Borrower Fails
Because federal funds sold are unsecured, the lender faces credit risk if the borrowing institution fails before repaying. The overnight maturity limits exposure, and both counterparties are regulated depository institutions, but the risk is not zero. During the 2008 financial crisis, banks grew wary of lending to each other and the market nearly seized up.
If a borrowing bank fails and enters FDIC receivership, the lender’s claim falls behind depositors in the priority order for the failed bank’s remaining assets:12Office of the Law Revision Counsel. 12 U.S. Code 1821 – Insurance Funds
- Administrative expenses of the receiver come first.
- Deposit liabilities come next, including both insured and uninsured deposits.
- General and senior liabilities follow, which is where an unsecured federal funds claim sits.
- Subordinated obligations come after that.
- Obligations to shareholders come last.
A bank that sold federal funds to a failed institution could recover less than the full amount owed, or nothing at all, depending on what is left after depositors are made whole. That priority structure is why banks monitor counterparty exposure carefully and why the market functions on trust and reputation as much as on pricing.
Limits on Lending to Affiliates
When a bank sells federal funds to an affiliated institution, federal law caps how large those transactions can be. Under Section 23A of the Federal Reserve Act, a bank’s covered transactions with any single affiliate cannot exceed 10 percent of the bank’s capital stock and surplus, and the aggregate of all transactions with all affiliates combined cannot exceed 20 percent.13Office of the Law Revision Counsel. 12 U.S. Code 371c – Banking Affiliates The caps prevent a bank from funneling cheap federal funds to affiliates in ways that could undermine its own stability or exploit the federal safety net. The Federal Reserve enforces the limits through Regulation W, and violations can bring enforcement actions.