What is the overnight rate, and why does everything hang off it?

Every yield curve you will ever look at is built on top of one number: the rate at which money is lent for a single night. Start there and the rest of fixed income stops being mysterious.

Why banks lend to each other overnight at all

Banks settle payments with each other in central bank reserves — deposits held at the central bank. When a customer of Bank A pays a customer of Bank B, reserves move from A to B. Millions of those payments run through the system every day, and they do not net out neatly. At the close of business some banks are short of reserves and some have more than they need.

So they trade. A bank with a surplus lends it overnight; a bank that is short borrows. The rate they agree is the overnight rate, and it is the shortest, simplest loan in finance: one night, so almost no time for anything to go wrong, and — for a solvent bank — almost no credit risk. That makes it the purest available price of money.

Why everything longer is built from it

A three-month rate is not an independent fact. It is, roughly, the compounded average of the overnight rates the market expects over the next ninety days, plus a small premium for term and credit. If the overnight rate is expected to sit at 4.00% for the whole period, a three-month risk-free rate lands near 4.00%. If the market expects the central bank to cut by 25 basis points halfway through, the expected average is about 3.875%, and the three-month rate reflects that.

This is why the overnight rate is the anchor. Change it — or change expectations about it — and every longer rate, every discount factor, and every asset priced off a discount factor has to move. The central bank does not set mortgage rates or corporate bond yields. It sets, and defends, one overnight number.

The arithmetic of one night

Money market interest is quoted on a simple, actual/360 basis in the US and euro area:

interest = principal × rate × days / 360

A bank ends the day $500 million short and borrows overnight at 4.30%:

500,000,000 × 0.0430 × 1 / 360 = $59,722

Sixty thousand dollars for one night on half a billion. It looks trivial, and that is exactly the point: the overnight rate is a small number applied to enormous balances, every single day, forever.

The 360 is a convention, and it travels with the currency rather than with the formula. Actual/360 is the US dollar and euro rule. Sterling is not on it: SONIA, sterling deposits and sterling repo all count actual/365. Same principal, same rate, different denominator — £100 million for one night at 4.00% is £11,111.11 on a 360-day year and £10,958.90 on a 365-day year. The 360-day figure overstates by about 1.4%, which is nothing on one ticket and real money across a book rolled every night. Check the currency before you divide.

Not one rate but a family

In the US alone the market publishes several overnight rates, because "borrowing overnight" happens in several different ways:

• EFFR — the effective federal funds rate, on unsecured overnight loans of reserves between banks.
• OBFR — the overnight bank funding rate, a broader unsecured measure that adds eurodollar deposits.
• SOFR — the secured overnight financing rate, based on overnight loans backed by Treasury collateral.

They usually sit within a few basis points of each other. When they stop doing so, something in the plumbing has changed — a theme this whole course keeps returning to.

In the data

Here is the whole family for one night, 24 September 2026, with the value of the loans each rate was measured on:

Five rates, and none of them is called "the overnight rate". They did not agree either: the two general collateral repo rates sat at 3.86% while SOFR, EFFR and OBFR sat at 3.88%. A figure quoted as "the overnight rate" has picked one of them, and the pick can move the answer by a couple of basis points.

Try it now

1. The table below shows SOFR (dollars), €STR (euros, listed as ESTR) and SONIA (sterling) on one date, 24 September 2026. Three currencies, three overnight rates, three different numbers.

2. Using the formula above, work out one night's interest on 100 million of each currency at its own rate — and give each leg its own day count: ÷ 360 for SOFR and €STR, ÷ 365 for SONIA. Sterling is actual/365, so the sterling leg is not a repeat of the other two with a different rate plugged in.
3. Below is the unsecured rate minus the secured one, EFFR minus SOFR, for every business day from 18 August to 24 September 2026. Describe its size neutrally: the largest reading either way, and where most days sit. You will learn what moves it in Unit 2.