Interbank overnight rate determinants

Abstract

Reserve requirement is a regulation of most world's central banks, whereby commercial banks must hold a certain fraction of customer deposits in reserves, either deposited at the central bank or in the bank vaults. While these reserves are calculated periodically, banks usually manage their books daily, which may result in reserve shortfall or surplus. This phenomenon has led to the emergence of the interbank market where banks transact with one another, trading interest rate instruments of various maturities. This paper focuses on the overnight interest rate, as it is assumed to be an indicator of the central bank's policy. Moreover, as the overnight rate is included in the yield curve construction, it implicitly influences the rates for all longer maturities. Finally, as an equilibrium in the reserve supply and demand, movements in the overnight interest rate reflect the dynamics in the interbank market. Here, the main interbank indices are described, before discussing some important features of the overnight rate, and the factors underlying its movements.