What is Term Federal Funds
Term federal funds are balances purchased in Federal Reserve accounts for more than a single day. Term federal funds usually have a maximum term of 90-days.
Banks and related financial institutions may need to obtain these funds when their borrowing needs last for several days, or they cannot merely borrow overnight funds. Borrowing funds overnight are the standard practice for financial institutions worldwide.
BREAKING DOWN Term Federal Funds
Term federal fund loans are unsecured and extended at low-interest rates. The rate at which these large financial institutions borrow is known as the federal funds rate. The federal funds rate is the interest rate that depository institutions, or banks, lend money to one another. The funds come from excess balances the bank owns which are held at the Federal Reserve and are used to meet Reserve requirements. Another term for the federal funds rate is the overnight rate. The overnight rate is usually the lowest rate available and available to only the most reliable, credit-worthy borrowers.
Term federal funds transactions that take place between two large banks or other financial organizations. A contract defines the specifics of the deal and includes the fixed interest rate of borrowing and repayment terms. The agreement may also stipulate whether the lender can call in the loan before it reaches maturity and if the borrowing bank can repay the funds early.
The Federal Open Market Committee (FMOC) meets eight times a year to set the federal funds rate. Led by Jerome Powell, the FMOC makes periodic adjustments to the rates based on open market operations and the supply of money required to meet target rates.
The Appeal of Term Federal Funds
There are several reasons why financial institutions find term federal funds to be a convenient and appealing tactic for efficient business operations.
For a bank or lending institution, the process of obtaining term federal funds is relatively simple. It is also financially appealing because of the minimal fees incurred. The method of transferring funds for term federal funds is somewhat similar to the process involved in exchanging overnight funds in what is known as the overnight market.
Banks also purchase term federal funds to lock in the current short-term interest rate in a rising rate environment. These funds resemble overnight federal funds which are not subject to reserve requirements. Reserve requirements are the dollar amount an institution must have on-hand at any given time. For this reason, they are often purchased instead of other comparable instruments with similar maturities.