In fact, the overnight repo market consists of several types of financial institutions (FI):

FI that do not participate in the federal funds market and do not receive interest on reserve balances, like money market funds, but participate in the repo market

US domestic banks that participate in the federal funds market, are eligible to receive interest on reserves and pay an insurance premium to the FDIC

FI that can participate in the federal funds market and repo market but do not receive interest on reserves, like GSEs

FI that participate in the federal funds market and repo, receive interest on reserves, but do not pay for deposit insurance to the FDIC, such as US branches of foreign banks.

Some questions:

(a) With the market segmentation described above, explain why interest on reserves is not a floor on the federal funds rate.

(b) If the repo rate and the federal funds rates are below interest on reserves, explain why there is an arbitrage opportunity created for US branches of foreign banks.

(c) Explain why GSEs are willing to lend at an interest rate below the rate paid on reserves.

(d) Explain the floor system currently being used by the FRS.