Federal funds sold are short-term loans, usually overnight, that one bank makes to another out of the reserve balance it keeps at the Federal Reserve. The name reflects the lender’s point of view: the bank “sells” reserves it does not need that day, collects interest, and gets the principal back the next business day. The loans are typically unsecured, settle instantly through the Fed’s wire system, and the rate negotiated on each transaction feeds into the effective federal funds rate that anchors borrowing costs across the U.S. economy.
What “Federal Funds” Means
Every commercial bank, savings institution, and credit union that qualifies as a depository institution keeps a balance in an account at one of the twelve regional Federal Reserve Banks. Those balances are federal funds. They work like a checking account the bank uses to settle payments with other banks, clear checks, and send wires, and because they are immediately available they are the most liquid asset a bank holds.
Before March 2020, banks were legally required to hold a minimum percentage of customer deposits in these accounts. The Federal Reserve reduced that reserve requirement to zero percent effective March 26, 2020, eliminating mandatory reserves for all depository institutions.1Board of Governors of the Federal Reserve System. Reserve Requirements Banks still hold substantial balances at the Fed. They need them to settle daily payments and cover unexpected withdrawals, and the Fed pays interest on those balances, which gives banks a reason to keep money there even without a mandate.
The federal funds market is where institutions with more reserves than they need on a given day lend to those that are 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
On the lending bank’s side, the trade is labeled “federal funds sold.” The bank has reserves it does not need for the day, and instead of leaving them to earn only the Fed’s administered rate, it lends them out for a slightly higher return. The borrowing bank records the mirror entry, “federal funds purchased.”3Board of Governors of the Federal Reserve System. Federal Reserve Supervisory Manual – Section 4005.1 Federal Funds
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. The lending bank instructs the Federal Reserve to move money from its reserve account into the borrower’s account. The next business day, the borrower returns the principal plus interest. Settlement is essentially instantaneous through the Fed’s electronic system, so there is almost no delay between agreeing to the loan and moving the funds.
The interest rate on each transaction is negotiated privately between the two parties and reflects how much supply and demand exist for reserves across the system at that moment. When reserves are plentiful, lending banks compete for borrowers and rates drop. When reserves are scarce, borrowers bid rates up. The volume-weighted median of all these privately negotiated rates on a given day becomes the effective federal funds rate.4Board of Governors of the Federal Reserve System. The Recent Evolution of the Federal Funds Market
Who Lends and Who Borrows
The federal funds market is not limited to commercial banks lending to one another. Savings institutions and credit unions participate too. The most striking feature of the modern market, though, is the dominance of Federal Home Loan Banks. These government-sponsored enterprises now account for more than 90 percent of the lending side.5Board 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 funds in the federal funds market at rates below what banks could earn from the Fed, which still beats earning nothing. Banks on the borrowing side profit from the spread between what they pay the Federal Home Loan Bank and what they earn on the reserves through the IORB rate. That dynamic drives much of the daily trading volume.
Other government-sponsored enterprises participate mostly as lenders. On the borrowing side, participants are almost exclusively domestic depository institutions with reserve accounts at the Fed.
How Federal Funds Sold Appear on the Books
For the lending bank, federal funds sold show up as a short-term asset on the balance sheet. The asset represents the principal owed back plus accrued interest, and since the loan matures overnight, the bank expects to collect within 24 hours. On the borrowing bank’s balance sheet, the mirror entry is a short-term liability, “federal funds purchased.”
On the standardized regulatory filings banks submit each quarter, known as the Consolidated Reports of Condition and Income, federal funds sold are reported on Schedule RC, line 3.a.6Federal Financial Institutions Examination Council. Instructions for Preparation of Consolidated Reports of Condition and Income These reports give regulators at the Federal Reserve, FDIC, and Office of the Comptroller of the Currency a detailed picture of each bank’s financial health. A bank that consistently reports large volumes of federal funds sold is signaling that it has more reserves than it needs for its own lending and settlement activity.
Credit Risk on an Unsecured Overnight Loan
Because federal funds sold are unsecured, the lending bank faces credit risk if the borrowing institution fails before repaying. The overnight maturity limits the exposure, and the fact that counterparties are regulated depository institutions provides some comfort. But the risk is not zero. It became painfully real during the 2008 financial crisis, when banks grew wary of lending to each other and the federal funds market nearly seized up.
If a borrowing bank does fail and enters FDIC receivership, an unsecured federal funds claim falls behind deposit liabilities in the statutory priority order for distributing the failed bank’s remaining assets.7Office of the Law Revision Counsel. 12 U.S. Code 1821 – Insurance Funds Administrative expenses of the receiver come first, then both insured and uninsured deposits, and only then do general unsecured creditors such as a federal funds lender get paid. Subordinated debt and shareholders fall below that. A bank that sold federal funds to a failed institution could therefore 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 exactly why banks watch counterparty exposure carefully.
How the Rate Ties Into Monetary Policy
The Federal Open Market Committee does not dictate the rate banks charge each other on these overnight loans. It sets a target range, and as of early 2026 that range sits at 3.50 to 3.75 percent.8Board of Governors of the Federal Reserve System. The Fed Explained The Fed then uses administered rates to keep the effective federal funds rate inside that range.
The most important of those tools is the interest rate on reserve balances, or IORB, the rate the Fed pays on all balances eligible institutions hold at Federal Reserve Banks.9Federal Reserve Board. Interest on Reserve Balances Frequently Asked Questions As of late 2025, the IORB rate is 3.65 percent.10Federal Reserve Board. Interest on Reserve Balances A bank with excess reserves has little reason to lend them in the federal funds market for less than the Fed will pay it risk-free, so IORB acts as a soft ceiling. In practice, the effective federal funds rate tends to sit just below the IORB rate, because the Federal Home Loan Banks that dominate the lending side cannot earn IORB and are willing to lend below it.5Board of Governors of the Federal Reserve System. Bankers Banks and Their Role in the Federal Funds Market
A note on older terminology. Before 2021, the Fed maintained separate rates for required and excess reserves, called IORR and IOER. When reserve requirements went to zero, the distinction lost its meaning, and the Fed consolidated both into a single IORB rate effective July 29, 2021.9Federal Reserve Board. Interest on Reserve Balances Frequently Asked Questions Older references to “IOER” describe the same basic concept.
Changes in the target range ripple outward quickly. The prime rate, which most banks set three percentage points above the upper bound of the target range, adjusts almost immediately, and that in turn moves interest rates on credit cards, adjustable-rate mortgages, home equity lines of credit, and business loans.
Federal Funds Sold vs. Repurchase Agreements
The repo market and the federal funds market get 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, a broader set of participants can use them, including securities dealers and money market funds that would never engage in unsecured lending. The federal funds market is narrower, limited to depository institutions and government-sponsored enterprises with Fed accounts. Repo rates and the effective federal funds rate usually track each other closely, but they can diverge under stress. In September 2019, a spike in repo rates spilled over into the federal funds market, briefly pushing the effective federal funds rate above the FOMC’s target range and prompting emergency intervention.11Board of Governors of the Federal Reserve System. Financial Stability Report – November 2019
For a bank treasurer deciding where to park overnight cash, the choice comes down to a risk-return tradeoff. 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.