Overnight Rate

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DEFINITION of 'Overnight Rate'

The interest rate at which a depository institution lends funds to another depository institution (short-term), or the interest rate the central bank charges a financial institution to borrow money overnight. The overnight rate is the lowest available interest rate, and as such, it is only available to the most creditworthy institutions.

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BREAKING DOWN 'Overnight Rate'

Because the amount of money a bank has fluctuates daily based on its lending activities and its customers' withdrawal and deposit activity, the bank may experience a shortage or surplus of cash at the end of the business day. Those banks that experience a surplus often lend money overnight to banks that experience a shortage so the banking system remains stable and liquid.

The overnight rate provides for an efficient method for banks to access short-term financing from central bank depositories. As the overnight rate is influenced by the central bank of a nation, it can be used as a good predictor for the movement of short-term interest rates for consumers in the broader economy. The higher the overnight rate, the more expensive it is to borrow money. In the United States, the overnight rate is referred to as the federal funds rate, while in Canada, it is known as the policy interest rate. The rate increases when liquidity decreases (when loans are more difficult to come by) and decreases when liquidity increases (when loans are more readily available). As a result, the overnight rate is a good indicator of the health of a country's overall economy and banking system.

The Federal Reserve influences the overnight rate in the United States through its open-market operations. The overnight rate, in turn, has an effect on employment, economic growth and inflation. This rate has been as high as 20% in the early 1980s and as low as 0% after the Great Recession of 2007.

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