The US Federal Reserve is exploring an overhaul of the Federal funds rate – a benchmark that underlies almost every financial transaction in the world – as it prepares for a rise in interest rates.

The Fed funds rate is the main measure of overnight US interest rates and is currently based on actual rates reported by brokers for overnight loans between US banks.

According to people familiar with the discussions, the Fed could redefine its main target rate so it takes into account a wider range of loans between banks, making it more stable and reliable.

Concerns have grown about the reliability of the Fed funds rate since the Fed began buying trillions of dollars of assets during three rounds of quantitative easing. US banks now have huge amounts of cash and have stopped borrowing or lending Fed funds, making the market illiquid.

With the Fed targeting rates close to zero, the reliability of Fed funds has been less important, but when the Fed starts raising rates – something markets expect it to do in the middle of next year – it needs to be sure that it is targeting a real benchmark.

In particular, the Fed is looking at redefining the Fed funds rate to include dollar loans between banks outside the US markets as well as traditional onshore loans between US banks. – Copyright The Financial Times Limited 2014