Overnight rate

Overnight rate

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The overnight rate is generally the rate that large bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...

s use to borrow and lend from one another on the overnight market
Overnight market
The overnight market is the component of the money market involving the shortest term loan. Lenders agree to lend borrowers funds only "overnight" i.e. the borrower must repay the borrowed funds plus interest at the start of business the next day...

. In some countries (United States Of America, for example), the overnight rate may be the rate targeted by the central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...

 to influence monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...

. In most countries, the central bank is also a participant on the overnight lending market, and will lend or borrow money to some group of banks.

There may be a published overnight rate that represents an average of the rates at which banks lend to each other; certain types of overnight operations may be limited to qualified banks. The precise name of the overnight rate will vary from country to country.

Background


Throughout the course of a day, banks will transfer money to each other, to foreign banks, to large clients, and other counterparties on behalf of clients or on their own account. At the end of each working day, a bank may have a surplus or shortage of funds. Banks that have surplus funds may lend them to or deposit them with other banks, who borrow from them. The overnight rate is the amount paid to the bank lending the funds.

Banks will also choose to borrow or lend for longer periods of time, depending on their projected needs and opportunities to use money elsewhere.

Most central banks will announce the overnight rate once a month. In Canada, for example, the Bank of Canada
Bank of Canada
The Bank of Canada is Canada's central bank and "lender of last resort". The Bank was created by an Act of Parliament on July 3, 1934 as a privately owned corporation. In 1938, the Bank became a Crown corporation belonging to the Government of Canada...

 sets a target bandwidth for the overnight rate each month of +/- 0.25% around its target overnight rate: the Bank of Canada does not interfere in the overnight market
Overnight market
The overnight market is the component of the money market involving the shortest term loan. Lenders agree to lend borrowers funds only "overnight" i.e. the borrower must repay the borrowed funds plus interest at the start of business the next day...

 so long as the overnight rate stays within its target band, but the Bank will use its reserves to lend or borrow in the overnight market to ensure that the overnight rate stays within its announced bandwidth.

Measure of liquidity


Overnight rates are a measure of the liquidity prevailing in the economy. In tight liquidity conditions, overnight rates shoot up. Overnight rates may also shoot up due to lack of confidence amongst banks, as was observed in the liquidity crunch of 2008.

In order to measure liquidity situation, the spread between risk-free rates and overnight rates is considered. The TED spread
TED spread
The TED spread is the difference between the interest rates on interbank loans and on short-term U.S. government debt . TED is an acronym formed from T-Bill and ED, the ticker symbol for the Eurodollar futures contract....

 is a liquidity indicator for the U.S., which is the difference between LIBOR and Treasury bills.

See also

  • Fed funds (US Federal Reserve overnight rate)
  • EONIA
    Eonia
    Eonia is an effective overnight interest rate computed as a weighted average of all overnight unsecured lending transactions in the interbank market. It has been initiated within the euro area by the contributing panel banks.It is one of the two benchmarks for the money and capital markets in the...

     (Euro
    Euro
    The euro is the official currency of the eurozone: 17 of the 27 member states of the European Union. It is also the currency used by the Institutions of the European Union. The eurozone consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg,...

     OverNight Index Average)
  • SONIA
    SONIA
    SONIA is the acronym for Sterling OverNight Index Average, the reference rate for overnight unsecured transactions in the Sterling market...

     (Sterling
    Sterling
    Sterling may refer to:* Sterling silver, a grade of silver* Pound sterling, the currency of the United Kingdom- Businesses :* Hotel Sterling, a former hotel in Wilkes-Barre, Pennsylvania, United States* Sterling Airlines...

     OverNight Index Average)
  • SARON
    SARON
    SARON is an overnight interest rates average referencing the Swiss Franc interbank repo market. It was launched by the Swiss National Bank in cooperation with SIX Swiss Exchange. Since 25 August 2009, SARON has replaced the previously used repo overnight index...

     (Swiss Average Rate OverNight)
  • MUTAN
    Mutan rate
    The Mutan interest rate is the Uncollateralised Overnight Call Rate in Japan. It is the reference rate for JPY overnight unsecured transactions in the Japanese market....

     (Japan
    Japan
    Japan is an island nation in East Asia. Located in the Pacific Ocean, it lies to the east of the Sea of Japan, China, North Korea, South Korea and Russia, stretching from the Sea of Okhotsk in the north to the East China Sea and Taiwan in the south...

    ese Uncollateralised Overnight Call Rate)
  • LIBOR (overnight rates quotes for various currencies in London money market
    Money market
    The money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers' acceptances, certificates of deposit,...

    )