Beyond “Corridor” and “Floor”: Reading Reserve Incentives

The country cases showed that a peg’s operating design cannot be understood from its name alone. The BIS taxonomy adds a sharper comparison: what does an additional unit of reserves cost a bank at the margin, and how many reserves are available in the system? This chapter uses those two dimensions to explain why labels such as corridor, floor, ceiling, and tiered are useful shorthand but incomplete guides to behavior. The reader can then compare a peg’s reserve incentives and liquidity position without assuming that similar labels produce similar outcomes.

Labels are shorthand, not a verdict

Traditional labels classify an operational framework by where the overnight money-market rate trades relative to the central bank’s standing-facility rates.

In a ceiling system, the central bank supplies reserves through its lending facility, and the market rate aligns near the rate charged on those loans. In a corridor system, the central bank supplies enough reserves for the market rate to sit between the lending and deposit rates. In a floor system, the central bank supplies a large enough quantity of reserves that the market rate trades near the rate paid on deposits at the central bank. A tiered system pays different rates on different portions of banks’ reserve holdings, creating another slope in the demand curve.

These labels answer an important operational question: where is the market rate relative to the facilities? They do not fully answer how banks behave. Two corridor systems can have very different corridor widths. A difference of a few basis points creates a much weaker incentive to move reserves than a difference of several percentage points. Two floor systems can also supply very different quantities of reserves, from just enough to reach the flat part of the demand curve to an amount far beyond what banks need for settlement.

The BIS therefore proposes two continuous dimensions. The first is the marginal opportunity cost of holding reserves. For a bank, an additional unit of reserves can be lent overnight in the market or left at the central bank’s deposit facility. The marginal opportunity cost is the difference between those returns. If the bank can earn substantially more by lending the unit than by depositing it, holding the reserve is expensive at the margin. The bank has a stronger incentive to economize on reserves and find a counterparty.

The second dimension is the aggregate quantity of reserves held by banks above any required level. This is not just a measure of how much money the central bank has created. Reserves are the safest and most immediately usable form of funding liquidity: unlike a bond or another high-quality liquid asset, they do not need to be sold or pledged before they can meet a payment. The quantity supplied therefore affects how banks manage liquidity risk, comply with supervisory expectations, and respond to a possible outflow.

flowchart LR D["Operational framework"] --> M["Marginal opportunity cost of reserves"] D --> Q["Aggregate reserve quantity"] M --> T["Incentive to trade or economize"] Q --> L["Immediately available liquidity buffer"] T --> O["Money-market behavior"] L --> O O --> F["Financial-stability and market-development outcome"]

The axes are related but not identical.