Interest on Required Reserves

The interest on required reserves (or IORR) is the rate a central bank pays on reserve balances that banks are obligated to hold under reserve requirements. This rate is separate from—and often different from—the rate paid on excess reserves, reflecting the central bank’s decision to treat mandatory and discretionary reserve holdings differently.

The distinction from excess reserves

When a bank has $100 million in deposits and a 10% reserve requirement, it must hold $10 million in reserves. That $10 million is required. If the bank holds $15 million, the extra $5 million is excess.

Before 2008, the Fed paid zero interest on both. When the Fed began paying interest on reserves, it had a choice: pay the same rate on required and excess reserves, or pay different rates?

The Fed chose to mostly treat them similarly—paying interest on both at rates that moved together. However, the Fed separately tracks the two rates analytically, because they have different effects on bank behavior. Required reserves must be held regardless of return (they are legally mandated). Excess reserves are discretionary, and their holding rate has a strong effect on lending.

Policy implications

By setting the IORR rate, the Fed influences banks’ willingness to hold reserves beyond the minimum. If IORR is very low or negative, banks have no incentive to hold more reserves than required; they lend out the rest. If IORR is high, banks are happy to hold abundant reserves, earning the attractive return.

This is a lever for controlling the money supply. Raise IORR and banks hoard reserves; lower it and they lend aggressively.

Practical use in modern monetary policy

Since the elimination of reserve requirements in March 2020 (during the COVID-19 crisis), there is technically no longer a “required” amount of reserves, and thus IORR becomes moot in a technical sense. However, the Fed still publishes interest-rate schedules that distinguish between reserve holdings of different sizes, essentially treating large holdings as if they were “excess” and thus subject to discretionary-use logic.

The Fed also continues to discuss IORR in policy frameworks because the concept remains analytically useful: it helps explain why banks hold reserves and what return they require to do so.

See also