M7.02 told you the Fed pays interest on reserve balances (IORB) and that this rate acts as a floor. Here is why, from arbitrage rather than definition, because the derivation is what makes the floor mechanical rather than a rule you memorize. A bank holding a spare reserve balance overnight has exactly two choices: leave it at the Fed, earning IORB risk-free with zero credit exposure and zero effort, or lend it to another bank in the fed funds market. No rational bank lends fed funds below IORB, because it could always earn more, with no risk, simply by leaving the money where it already sits. That single sentence is the entire floor mechanism, it is not a rule the Fed enforces by fiat, it is an arbitrage condition every profit-seeking bank enforces on itself.
Why does the fed funds rate trade below IORB?
Why, then, does the effective federal funds rate (EFFR) ever trade below IORB, as M7.02 already noted it does? Because not every fed-funds-market lender can earn IORB, only banks and a short list of other institutions hold accounts at the Fed. The Federal Home Loan Banks (FHLBs), large habitual lenders in the fed funds market, cannot earn IORB themselves, so they are willing to lend at a shade below it, and banks that borrow from them and immediately redeposit the cash at IORB pocket the spread, an arbitrage that competes EFFR down toward, but not to, IORB. As of July 23, 2026 (Federal Reserve / New York Fed published rates: check the current at federalreserve.gov and newyorkfed.org): the FOMC's target range stood at 3.50%–3.75% (raised to 3.75%–4.00% on 16 September 2026; a 25-basis-point-wide range, the Fed's format, versus the RBI's single-point repo rate, the format difference M7.02 already flagged); IORB was 3.65%, sitting 15bp above the floor of the range and 10bp below its ceiling; EFFR printed 3.63%, exactly the 2-basis-point-below-IORB pattern the FHLB arbitrage above predicts; and the secured overnight rate, SOFR, printed 3.64%, a hair above EFFR because it prices a different, collateralized market with a different participant mix. The Fed's ON-RRP facility (money-market funds and other non-bank counterparties lending cash to the Fed overnight against Treasury collateral) is set, by standard Fed operating practice, at the bottom of the target range (3.50%), forming a second, broader floor beneath the whole non-bank financial system, since money funds cannot hold reserve accounts either.
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What is the difference between a floor and a corridor system?
A corridor system, by contrast, the RBI's SDF/repo/MSF structure M7.02 already gave you (SDF 5.00% floor, repo 5.25% policy midpoint, MSF 5.50% ceiling as of mid-2026, referenced here exactly, not re-derived; after the 7 October 2026 hike the corridor is 5.25%, 5.50% and 5.75%), brackets the market on both sides with standing facilities at a fixed spread around the policy rate, and typically operates with a scarcer aggregate reserve supply than a floor system, so the overnight rate has to be actively pinned between the two rails rather than left to settle near a single administered rate. The operational difference between "floor" and "corridor" is therefore not a matter of vocabulary but of how much reserve supply sits relative to demand: flood the system with reserves (the post-2008 and post-2020 US experience) and the overnight rate collapses toward whatever rate you pay on the reserves themselves, a floor system, almost by accident of abundance. Keep reserves scarcer and deliberately bracketed on both sides, the RBI's ordinary operating posture, and you have a corridor.