Because then you have counterparty risk, which means you then have greater regulatory/compliance costs and have to pay up to 0.4% on assets for FDIC insurance.
Counterparty risk on Fed Funds loans, which are for one day only and to solid, highly regulated financial institutions, is negligible - that's why it's treated as the risk-free rate.
Would you need FDIC insurance if you only took deposits from financial institutions?
> Why is it so crucial to their business model that the customers' deposits are deposited directly with the Fed
Note that whether interest was earned via IOER or via the Fed Funds market, the funds would be deposited with the Fed either way (whether in the bank's own Fed account or overnight in the Fed account of the counterparty of a Fed funds loan).
It wouldn't be possible to accept transfers from other banks, to send funds to other banks or to participate in the Fed Funds market unless the bank had an account with the Fed.
On the point of "risk-free", the TED spread was north of 1% for much of the 20 months between August 2007 and April 2009, and peaked at over 4%. So it's not always what I'd call negligible risk. https://fred.stlouisfed.org/series/TEDRATE
Would you need FDIC insurance if you only took deposits from financial institutions?