Regulatory Requirements of Banks and Arbitrage in the Post-Crisis Federal Funds Market

39 Pages Posted: 28 Apr 2023

See all articles by Rodney Garratt

Rodney Garratt

University of California, Santa Barbara (UCSB)

Sofia Priazhkina

Government of Canada - Bank of Canada

Date Written: April 26, 2023

Abstract

This paper explains the nature of interest rates in the U.S. federal funds market after the 2007-09 financial crisis. We build a model of the over-the-counter lending market that incorporates new aspects of financial markets: abundance of liquidity, different regulatory standards for banks, and arbitrage opportunities created by limited access to the facility granting interest on excess reserves. The model determines the equilibrium federal funds rate as a function of the policy rates and explains the "leaky floor" phenomenon: federal funds rates being strictly below the interest rate paid on reserves. Using the model, we explain the impact of raising government yields and tighter Liquidity Coverage Ratio (LCR) and the Supplementary Leverage Ratio (SLR) requirements on the federal funds rates.

Keywords: federal funds market, monetary policy implementation, bank regulation, liquidity coverage ratio, leverage ratio, FHLB

JEL Classification: E42, E58, G2, G28

Suggested Citation

Garratt, Rodney and Priazhkina, Sofia, Regulatory Requirements of Banks and Arbitrage in the Post-Crisis Federal Funds Market (April 26, 2023). Available at SSRN: https://ssrn.com/abstract=4430240 or http://dx.doi.org/10.2139/ssrn.4430240

Rodney Garratt

University of California, Santa Barbara (UCSB) ( email )

South Hall 5504

Sofia Priazhkina (Contact Author)

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

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