Every commercial bank in the United States holds an account at a Federal Reserve Bank. The balance in that account is what banks actually use to pay each other.
Reserves are the settlement asset
When money moves between two banks, the transfer is completed by debiting one bank's reserve account and crediting the other's. Nothing physical moves.
Customer deposits are liabilities of individual banks and are not transferable between them directly. Reserves are the common asset that makes cross-bank payment possible.
This is why the central bank sits at the center of the payment system regardless of monetary policy. It operates the ledger on which interbank obligations are extinguished.
What changed after reserve requirements
Reserves were historically held partly to satisfy a required ratio against deposits. That requirement was reduced to zero, but reserve balances did not disappear.
Banks now hold reserves because they need them for settlement and liquidity, and because the central bank pays interest on the balances held.
The system shifted from one where reserves were scarce and rationed to one where they are abundant, which changed how policy rates are transmitted.
How interest on reserves steers rates
Paying interest on reserve balances sets a floor under short-term rates, since a bank has little reason to lend to another party below what it earns risk-free at the central bank.
Adjusting that administered rate moves the whole complex of short-term rates without requiring the central bank to change the quantity of reserves in the system.
Additional facilities extend a similar floor to institutions that do not hold reserve accounts, broadening the reach of the mechanism beyond banks.
Why banks still borrow from each other
Reserves are distributed unevenly. A bank receiving large payment inflows accumulates them while another sends them out, so overnight lending redistributes balances.
The rate on those overnight loans between institutions is the policy target rate, observed rather than dictated, and it moves within a corridor set by administered rates.
Repurchase agreements now carry far more of this activity than unsecured lending, so the reference rates used across the financial system reflect collateralized borrowing.
What this means for deposit rates
A bank comparing what it earns on reserves against what it pays depositors has a clear reference point for whether raising deposit rates is worthwhile.
Banks flush with deposits and limited lending opportunities have little incentive to compete for more, which is one reason deposit rates lag policy changes.
The relationship is a competitive decision rather than a mechanical link, which explains why identical policy moves produce different deposit pricing across institutions.