Fed Rate Hike Raises Costs of Funding Global Commerce

On September 16, the Federal Reserve raised the federal funds rate by a quarter percentage point to 3.75% to 4%, with the interest rate paid on reserve balances increasing from 3.65% to 3.90%. This decision impacts the costs of funding global commerce, particularly for banks and multinational corporations.

The Fed's move affects the economics of liquidity, including funds used for executing payments in different currencies and jurisdictions. Correspondent banking, which most cross-border payments rely on, sees the impact of this rate increase. Banks maintain balances in advance to ensure payments settle, but this arrangement comes with a financial cost as some cash remains idle.

The higher price on bank liquidity means banks face an opportunity cost when using dollar liquidity for alternative purposes. For low-yielding or noninterest-bearing dollar balances held elsewhere for payment purposes, the opportunity cost rises. Banks have more reason to examine their liquidity positioning and efficiency after a rate increase.

Corporate working capital is also affected by the rate increase. Companies using floating rate credit facilities may face higher financing expenses. Cross-border payments demand liquidity, and payment delays do not necessarily mean available cash remains unavailable for the entire settlement period. Faster payment processing and settlement can help reduce liquidity costs, but this cannot eliminate the financial cost created by higher interest rates.