Understanding Overnight Lending Stress: SOFR vs IORB

You’ve learned that liquidity drives markets. Now it’s time to measure it.

The SOFR vs IORB spread is your first indicator, and it’s one of the most visible ways to gauge stress in the overnight lending market, where banks borrow from each other every single night.

Think of it as the financial system’s pulse. When this pulse is steady, money flows smoothly, and markets remain calm.

When it spikes, it signals that banks are scrambling for cash, a warning sign that can appear days or even weeks before broader market turmoil.

In this lesson, you’ll learn exactly what these two rates measure, why the relationship between them matters, and most importantly, how to translate changes in this spread into actionable trading decisions.

By the end, you’ll understand how to spot funding stress before it becomes a crisis, giving you the same early warning system that institutional traders rely on.

I’ll write a beginner’s section on reserves that fits seamlessly with this lesson’s style. Here’s what I’d recommend placing before the “What Are These Rates?” section:

Understanding Reserves: The Foundation

Before we dive into SOFR and IORB, you need to understand what bank reserves actually are.

What Are Bank Reserves?

Bank reserves are deposits that commercial banks hold at the Federal Reserve, which they use to settle payments and meet liquidity needs.

Yes, banks have their own bank account at the Fed.

Reserves are the safe “cash buffer” that banks keep so they can make payments and meet withdrawals when customers move money around.

When you put money in the bank, the bank does not immediately lend out every dollar; it keeps some very safe, very liquid money aside as reserves so it can give cash back on demand and settle payments to other banks.

These reserves are part of the bank’s assets and are a key tool for keeping the banking system stable and liquid.

Two Types of Reserves:

1. Required Reserves: The minimum amount banks MUST hold (though this is currently zero, it used to be about 10% of deposits),
2. Excess Reserves: Any amount above the requirement. This is where IORB becomes important.

Before 2020, banks had to hold a minimum fraction of certain deposits as “required reserves,” and any balances above that level were called “excess reserves.” Since March 2020, the Fed has set reserve requirements to zero, so in practice, the system now just refers to “reserve balances,” though the old required/excess language is still useful for historical context.​

Reserves Earn Interest

Banks that hold reserve balances at the Fed earn Interest on Reserve Balances (IORB) on those balances. IORB is set by the Fed and acts as a key policy rate: a bank will not normally lend funds overnight for less than it can earn risk‑free by leaving those funds at the Fed.

Banks have a choice every night:

If you HAVE excess reserves:

• Option A: Keep them at the Fed and earn IORB (the “safe” rate).
• Option B: Lend them to other banks and non-banks in the repo market overnight and earn SOFR.

If you NEED reserves:

• Option A: Borrow from other banks and non-banks in the repo market at SOFR.
• Option B: Borrow from the Fed’s discount window (typically a higher rate than IORB).

Because the discount window rate is higher and can be seen as a last resort, banks generally prefer to borrow in private markets first.​

The repo market is a private, over‑the‑counter market where large financial institutions borrow and lend cash to each other for very short periods (often overnight) using safe securities like U.S. Treasuries as collateral, making it work like a short‑term, collateralized loan.

What Are These Rates?

Think of the financial system as having a “pulse” that you can measure every night. Here’s what you’re looking at:

• IORB (Interest on Reserve Balances): The baseline interest rate the Federal Reserve pays banks to keep money parked at the Fed. Think of it as the “safe” rate – the floor.
• SOFR (Secured Overnight Financing Rate): The actual rate banks charge each other to borrow money overnight, using Treasury bonds as collateral.

In addition to IORB and SOFR, the Federal Reserve also uses the Overnight Reverse Repurchase Agreement (ON‑RRP) facility as a supplementary floor under short‑term rates. ON‑RRP allows eligible nonbank institutions, such as money market funds and GSEs, to lend cash to the Fed overnight in exchange for Treasury collateral, earning the ON‑RRP rate. Functionally, it extends the “safe parking rate” concept of IORB beyond banks. When market rates get too low, these investors can simply put their cash into ON‑RRP instead, which helps keep overnight secured rates like SOFR from falling too far.

Why This Matters

In normal times, SOFR stays at or slightly below IORB.

Why?

Because under an ample‑reserves regime, SOFR has historically traded a few basis points below IORB on average.

This is because banks can earn IORB risk‑free at the Fed, and non‑bank lenders (MMFs, GSEs) who cannot earn IORB are willing to lend cash a bit cheaper in repo, so banks/arbitrageurs keep SOFR near but typically under IORB.

When SOFR rises above IORB = Red flag!

It means banks are so desperate for cash they’re willing to pay above the “safe” rate.

If SOFR moves noticeably and persistently above IORB, it signals that some institutions are willing to pay more than the “safe” IORB rate to obtain cash, suggesting that reserves or balance‑sheet capacity are becoming scarce.

Short‑lived or very small moves above IORB can reflect technical factors or quarter‑end balance‑sheet effects, but sharp spikes are widely read as signs of significant funding stress that often prompt Fed attention or intervention.

The Warning Levels (From Green to Red)

🟢 Normal: SOFR Below IORB

What’s happening: Money is flowing smoothly through the banking system

What you see: SOFR might be 0.05% to 0.10% below IORB

What to do: Nothing special. Markets are functioning normally.

Example: If IORB is 5.40%, SOFR might be 5.33%. This is normal.

🟡 Early Warning: SOFR Equals IORB

What’s happening: Banks are starting to scramble for funding

What you see: SOFR rises to match IORB exactly

What to do: Add some protection to your portfolio (hedges). This could be:

• Taking some profits on risky positions.
• Buying a small amount of gold.
• Reducing your stock exposure by 10-20%.

Think of it as: The “check engine light” just came on. Might be nothing, but pay attention.

🔴 Alert: SOFR Above IORB for 2+ Days

What’s happening: Real funding stress. Banks can’t find enough cash even at elevated rates.

What you see: SOFR stays 0.10%+ above IORB for multiple days

What to do: Expect the Federal Reserve to inject liquidity (emergency lending). Start positioning for what comes after:

• Keep some cash ready.
• Watch for Fed announcements.
• The injection usually causes a relief rally in stocks.

Historical example: This happened during the 2019 repo crisis when SOFR spiked to 5.25% while IORB was 2.10%.

🚨 Danger Zone: SOFR Above IORB for 5+ Days

What’s happening: Severe market stress. Large hedge funds are being forced to sell (deleveraging).

What you see: SOFR persistently elevated, potentially spiking higher

What to do – Two phases:

Phase 1 (During the crisis):

• Reduce stock positions tactically (especially tech and high-valuation stocks).
• Buy gold as insurance.
• Consider bitcoin if you’re comfortable with volatility.

Phase 2 (After Fed intervenes):

• The Fed WILL act with massive liquidity.
• This eventually becomes bullish for gold, bitcoin, and stocks.
• Be ready to buy the dip.

Real-world context: In March 2020 (COVID crash), SOFR spiked as the Treasury market froze. The Fed then unleashed QE, leading to a massive rally in assets.

Quick Reference Card

Days SOFR > IORB	What It Means	Your Move
0 (SOFR below)	✅ All clear	Stay invested
1 day	🤔 Watch closely	No action yet
2-4 days	⚠️ Stress building	Reduce risk 10-20%
5+ days	🚨 Crisis mode	Defensive position, prepare for Fed action

Where to Check This

You don’t need a Bloomberg terminal. Here’s how to monitor:

1. New York Fed website publishes SOFR daily (Google “NY Fed SOFR”)
2. IORB rate can be found on the Federal Reserve Economic Data (FRED) website.
3. Calculate the spread: SOFR minus IORB (if positive, that’s your warning signal)

You can also view this chart on TradingView:

Bottom Line

You’re watching for one simple pattern: Is the overnight borrowing rate higher than the safe rate?

• If yes, for just a day → Could be technical, keep watching.
• If yes, for 2-4 days → Time to get cautious!
• If yes, for 5+ days → Major stress, Fed will have to act.

The beauty of this indicator is its objective and real-time nature. No opinions, no forecasts, just pure market stress showing up in the data.