How does a central bank actually enforce its target rate?
A central bank announces a target. It does not, however, get to dictate the price at which two private banks lend to each other. So how does the announcement become reality? Through arbitrage — deliberately engineered.
The corridor: a ceiling and a floor built from facilities
The classic design gives every bank two standing options with the central bank itself:
- A lending facility — borrow from the central bank against collateral at a stated rate, any day, no questions asked. No bank will pay the market more than this, because it always has this alternative. That is the ceiling.
- A deposit facility — park surplus reserves at the central bank at a stated rate. No bank will lend to the market for less than this. That is the floor.
The market rate is boxed in between. Suppose the deposit rate is 3.75% and the lending rate is 4.25%, with a 4.00% target in the middle: the corridor is 50 basis points wide and the market rate should live inside it.
In a corridor system, the central bank then keeps reserves scarce and fine-tunes the supply day by day so the overnight rate lands near the middle. It is precise, it is fiddly, and it requires constant operations.
The floor: make reserves abundant instead
After 2008, balance sheets ballooned and reserves went from scarce to enormous. Fine-tuning a quantity became pointless — the system was miles out on the flat part of the demand curve, where adding or draining a few billion changes nothing.
So the design flipped. In a floor system the central bank supplies more reserves than the banking system needs and simply pays interest on them. Banks will not lend below what they can earn risk-free at the central bank, so the overnight rate is pinned near that administered rate. The dial is now the rate paid on reserves, not the quantity supplied.
The Federal Reserve runs an "ample reserves" version of this with three components: IORB, the interest paid on reserve balances; the overnight reverse repo facility (ON RRP), a sub-floor open to money funds and government-sponsored enterprises that cannot earn IORB; and the Standing Repo Facility, a ceiling that lets eligible counterparties borrow cash against Treasuries. Note also that since December 2008 the FOMC targets a range, typically 25 basis points wide, rather than a single point — an honest acknowledgement that a market rate cannot be pinned to a decimal.
Floors leak, and the leak is instructive
In theory nobody lends below the floor. In practice they do, because not everyone has access to it. In the US, Federal Home Loan Banks lend federal funds but cannot earn IORB, so they lend a few basis points below it — which is why the effective fed funds rate has often traded slightly under IORB. In the euro area, €STR routinely fixes a few basis points below the ECB's deposit facility rate for the same reason: several €STR counterparties have no deposit-facility access.
The ECB has also been actively redesigning. In March 2024 it published an operational framework review, and from September 2024 it narrowed the spread between its main refinancing rate and the deposit facility rate from 50 to 15 basis points, moving toward a demand-driven floor. The marginal lending facility remains 25 basis points above the main refinancing rate.
In the data
Both designs, on one day:
The ECB's corridor is three rates: on 24 September 2026 the deposit facility at 2.50%, the main refinancing rate at 2.65% and the marginal lending facility at 2.90%, floor, middle and ceiling, 15 and 25 basis points apart as described above. The Fed's target is a band, 3.75% to 4.00%, so it takes two numbers rather than one. "The policy rate" as a single number fits neither central bank.
Try it now
- Below are the policy rates of the Fed and the ECB on 24 September 2026, with the Bank of England's single rate alongside. Identify the target range in one and the deposit facility rate in the other.
- The same day's funding spreads are below, all six. Find the unsecured overnight rate minus the midpoint of the target range (the row marked EFFR minus middle of Fed range). How many basis points off the middle does it sit?
- From the same table take SOFR minus the bottom of the range and the top of the range minus SOFR, and confirm the secured rate is sitting inside the box: both must be positive, and the two together should equal the width of the Fed's range. Describe where in the box, and stop there.