Sept. 16 (Bloomberg) -- The Federal Reserve added $50 billion in temporary reserves to the banking system when it arranged overnight repurchase agreements, or repos.

The rate for overnight loans between banks had opened at 3.75 percent, above the Federal Reserve's targetrate, as American International Group Inc.'s credit rating cut increased banks' reluctance to lend. The rate dropped to the central bank's target of 2 percent after the cash injection.

The Fed added $70 billion in reserves to the banking system yesterday, the most since the September 2001 terrorist attacks, to bring borrowing costs down after the bankruptcy of Lehman Brothers Holdings Inc. triggered a hoarding of cash. Funds opened at 3.5 percent yesterday.

``From a pure reserve perspective, the desk might not need to arrange any repos at all today,'' Wrightson ICAP analysts wrote in a note. ``From a dealer-funding perspective, another round of large morning repos may have a calming effect.''

Funds traded to as high as 6 percent yesterday, or 4 percentage points above the central bank's target rate for overnight loans between banks, according to ICAP Plc, the world's largest inter-dealer broker. That margin was the greatest at least since Bloomberg began tracking the data in 1998. The rate closed at 0.25 percent yesterday, and reached as low as 0.01 percent.

The Fed will lower its target rate by a quarter percentage point to 1.75 percent, futures trading showed. Contracts on the Chicago Board of Trade put the odds on a cut at 96 percent, compared with 2 percent a week ago. Of the 105 economists surveyed by Bloomberg News, 100 expect the Fed to leave rates unchanged today.

Foreign Central Banks

Central banks from Tokyo to Frankfurt injected cash into their financial systems in a bid to calm markets.

The European Central Bank awarded 70 billion euros ($99.8 billion) in a one-day money-market auction today. The Bank of Japan added a total of 2.5 trillion yen ($24 billion) and the Bank of England pumped in 20 billion pounds ($36 billion). Counterparts in Australia and Switzerland took similar steps.

Banks' demand for the security of cash rose again after AIG had its credit ratings cut by Standard & Poor's and Moody's Investors Service yesterday, threatening efforts to raise funds to keep the company afloat and roiling global financial markets.

The so-called effective funds rate was 2.93 percent yesterday, according to ICAP. The rate was from 2.1 percent on Sept. 12, according to The Federal Reserve Bank of New York reports daily the official effective funds rate, for the previous trading session. It is a weighted average rate of unsecured overnight lending transactions. A basis point is 0.01 percentage point.

Single-Tranche OMO

The Fed will also auction $20 billion in 28-day repos for mortgage-backed securities for one-day forward delivery that it has been arranging on Tuesdays.

The forward transaction is part of the Fed's so-called Single-Tranche OMO Program. Under the program announced March 7, the Fed agreed to make up to $100 billion available through weekly 28-day repurchase agreements.

The Fed has $78 billion in repos maturing today.

In repos, the Fed buys U.S. Treasury, mortgage-backed and so-called agency debt from its 19 primary dealers for a set period, temporarily raising the amount of money available in the banking system. At maturity, the securities are returned to the dealers, and the cash to the Fed.

Repos help maintain enough money in the system to keep overnight interest rates close to the central bank's target. They don't signal a policy shift.

To contact the reporter on this story: Liz Capo McCormick in New York at Emccormick7@bloomberg.net

Last Updated: September 16, 2008 08:36 EDT