How A Change In The US IORB Could Gently Reshape Caribbean Bank and Sovereign Risk.

The US FED, Interest on Reserve Balances (IORB) may seem far removed from Caribbean economies, but any move to repeal or lower it could send shock waves through global dollar funding systems. This article explains how countries like Trinidad and Tobago (T&T) could feel the effect through changes in offshore dollar costs, bank liquidity, and government borrowing. No alarm, just understanding the pipes.

IORB is the interest rate the FED pays banks to keep money at the central bank. Since 2008, it has acted as the floor for short-term US interest rates, anchoring everything from repo markets to Treasuries. If it’s removed, banks, especially large US and foreign ones, may shift trillions from FED reserves into higher-yielding assets like short-term Treasuries or money market instruments.

That rush could cause yields to drop across these markets and distort how money is priced. More importantly, offshore markets like Eurodollar and FX swaps, which use IORB as a guidepost, would lose a key benchmark. This can lead to more volatile currency hedging costs, unstable basis spreads, and tighter global dollar funding. The US Congress is exploring the removal of the IORB because some lawmakers argue it distorts free market interest rates and gives the FED too much control over short-term funding markets. Critics, especially those aligned with a more market driven or anti-FED view, believe paying interest on reserves encourages banks to park excess cash at the FED rather than lend it out, reducing credit availability and artificially inflating the size of the Fed’s balance sheet. Removing IORB is framed by proponents as a way to restore a more "organic" interest rate system driven by market forces rather than central bank-administered rates

Source - FRED

Caribbean banks like Republic Financial Holdings, NCB Financial Group, and First Citizens Bank don’t have direct FED accounts. But they rely heavily on US dollar assets and funding, such as:

• US Treasury bills and USD bonds

• Deposits in US correspondent banks

• USD loans and trade credit for regional clients
  

So, when IORB drops, yields on their dollar assets fall too. This hits profits. And if offshore dollar markets get shaky, dollar borrowing costs could rise, making liquidity harder to manage.

Source - 2024, Annual Reports various.

Worse, if these banks have short-term USD liabilities but long-term USD loans, they’re exposed to losses or cash gaps if the market shifts suddenly. In essence, even without direct Fed access, Caribbean banks are tied into the US dollar system and IORB is a key part of that system’s stability. That’s because SOFR, the rate many USD loans and funding instruments are based on, relies on IORB to stay anchored. IORB acts as a floor for short-term interest rates: if banks can earn a safe return by holding reserves at the FED they won’t lend out dollars in the repo market for less. This keeps SOFR and other money market rates stable. But if IORB is repealed or significantly reduced, that floor disappears. Cash would flood into alternatives like T-bills and repo, dragging SOFR down. For banks holding short-term USD assets like repos or T-bills, income would fall. If their USD liabilities are floating-rate or harder to reprice, funding costs may stay elevated. This imbalance, where assets earn less while liabilities remain costly, can compress margins, drain liquidity, and weaken capital over time.

Source - Tradeview

Caribbean countries as well are not immune to the shift. T&T, for example, operates a managed exchange rate system where the CBTT allocates dollars to banks using quotas. It might seem isolated from global shifts, but these dollars come from offshore sources, energy export earnings, foreign reserves, and US bank deposits, all of which depend on global dollar liquidity. Countries like Jamaica, which have more flexible exchange rates and issue Eurobonds, are even more directly exposed to international markets. But in both systems, IORB’s repeal could destabilize dollar liquidity, driving up hedging and borrowing costs, while compressing bank profit margins and putting stress on trade finance.

T&T’s Net International Investment Position (NIIP) and foreign direct investment (FDI) liabilities, averaging $8 to 10B, reveal a deep reliance on foreign capital. If global dollar funding tightens, this could affect both new capital inflows and rollover of old debts. And since CBTT’s FX allocation model depends on continued access to these external dollars, a disruption could challenge the country’s currency management.

Source - CBTT

Added to that, T&T and its Caribbean peers borrow in both local and USD-denominated debt. But the foreign currency portion becomes more vulnerable if IORB is repealed. That’s because global investors may flood into safer US assets, making it costlier for emerging markets to raise or refinance USD debt. Local banks, which often act as key buyers or dealers for state and SOE bonds, might reduce their support if they face tighter USD liquidity. At the same time, Caribbean banks using US repo or MMF channels may find those pipelines less predictable.

Source - CBTT

Even though Caribbean economies lack the deep financial markets of the US, their structural dependence on the USD ties them closely to global liquidity conditions. The FED’s Interest on Reserve Balances (IORB) may seem like a domestic policy tool, but its repeal would send ripples through emerging markets, with real implications for banking system stability, foreign reserve dynamics, and sovereign borrowing costs. This isn’t a call for alarm, Caribbean banks won’t collapse, nor will sovereign ratings nosedive overnight. But it is a meaningful shift in the plumbing of global finance. And in today’s interconnected system, even subtle changes in how the dollar is priced and recycled can reshape risk and funding flows. Going forward, policymakers and investors alike should closely monitor offshore dollar funding spreads, FX inflows and outflows at regional banks, shifts in the valuation of foreign asset portfolios, and widening spreads on USD-denominated sovereign debt. Reform, not rupture, is the message but in a tightly wound system, even small valves matter.