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In the context of the Fed, what are the reasons that the ON RRP facility is structured such that loans are collateralised?

If we assume the Fed has zero credit risk, what is the benefit of actually exchanging Treasuries for reserves? The Fed can be assumed to service the interest payment and principal the next day, so in theory the collateral is not needed.

Is it simply to prevent "volatility" on the commercial banks balance sheets, where the loan principal suddenly "disappears"?

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Fair question. I can think of two reasons (a) the main users of the RRP, such as money market funds, are usually permitted to invest in either securities or repo. The unsecured instrument you describe sounds like it wouldn’t fall into either category. (B) traditionally , the Fed was already set up to perform Open Market Operations using repos, so it was operationally easy to extend that to create the RRP.

Also note that the unsecured instrument you describe does exist - it is the Interest on Reserve Balances whereby banks can park their excess cash at the Fed - but this is only available to banks.

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  • $\begingroup$ Great point about the IORB - I suppose it transforms the question into why the Fed specifically chose to introduce the ON RRP as opposed to expanding the entities eligible to receive interest on reserves. I think that has already been asked on this site! $\endgroup$
    – masiewpao
    Commented Jun 16 at 20:29

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