The Flat IORB Problem
Under the current flat IORB structure, every dollar of reserve balances — whether held to meet genuine operational needs or accumulated purely as speculative excess — earns the same rate. A bank holding $500 billion in reserves earns the same per-dollar return as one holding the minimum required for intraday settlement. This uniform pricing creates no price incentive to economise on reserve holdings, as there is no marginal cost to holding more.
In contrast, the European Central Bank and other central banks have implemented tiered reserve remuneration systems that pay a higher rate on reserves up to a "required" or "exempt" tier and a lower (sometimes zero or even negative) rate on reserves above that threshold. This creates a direct financial incentive for banks to reduce excess reserve holdings by lending them out to reserve-scarce counterparts in the interbank market.
The Policy Option
Replace the flat IORB rate with a two-tier or multi-tier schedule. For example, a simple two-tier system might pay full IORB on reserves up to some benchmark level (e.g., 10–15% of a bank's risk-weighted assets, or some multiple of required reserves under a notional reserve requirement) and pay a reduced rate — say IORB minus 50 basis points — on reserves above that threshold.
The penalty tier creates a flow: banks with excess reserves in the penalty tier have a strong incentive to lend those reserves in the federal funds market or repo market to banks constrained below their tier threshold. Interbank markets would become more active, reserves would circulate more efficiently through the banking system, and aggregate reserve demand would fall as the system requires fewer total reserves to ensure adequate distribution.
ECB Experience
The ECB introduced tiered reserve remuneration in September 2019, exempting reserves up to six times a bank's minimum reserve requirement from the negative deposit rate then in force. Analysis by ECB staff (including work cited in the paper) found the system was effective in reducing excess reserve holdings, improving interbank market functioning, and reducing bank funding costs without undermining monetary policy transmission.
However, the U.S. context differs: the Fed does not currently impose negative rates, and the mechanism operates through a penalty on excess rather than a bonus for required reserves. The design of tiers and thresholds in a positive-rate environment is less well-tested than the ECB's negative-rate experience.
Effect highly sensitive to tier thresholds and penalty spread. Paper notes this option is most effective as a complement to Option 07 (EFFR above IORB), not as a standalone.
Interaction with Option 07
Tiering is most naturally paired with the corridor system (Option 07). In a corridor system, banks already face a scarce-reserves environment where the marginal cost of hoarding reserves is the opportunity cost of lending them out. Tiering adds an explicit penalty that reinforces this dynamic, potentially allowing the Fed to achieve corridor-system effects with a less dramatic reduction in total reserve supply.