The two-tier system for remunerating excess reserve holdings
In September 2019, the Governing Council of the ECB announced the introduction of a two-tier system for excess reserve remuneration (tiering) to support the bank-based transmission of monetary policy, thereby safeguarding the accommodative monetary policy stance.
The system entered into force on 30 October 2019 and exempted part of credit institutions’ excess reserves with the central bank from the then negative remuneration at the deposit facility rate. It was suspended on 27 July 2022, following the Governing Council’s decision to raise the deposit facility rate out of negative territory.
Within the scope of the tiering system, all credit institutions subject to minimum reserve requirements have a limit of excess reserves that is actually remunerated at a rate of 0%. This limit is based on a multiple of an institution’s minimum reserve requirements, adopted under a decision of the Governing Council of the ECB, which may change it over time.
The two-tier system entered into force with the multiplier set to six. At its meeting on 8 September 2022, the Governing Council decided to suspend this system, setting the multiplier to zero.
What are excess reserves
The ECB requires credit institutions established in the euro area to hold the required minimum reserves (in the form of deposits) on accounts with their national central bank.
Compliance with minimum reserve requirements is determined at the end of each maintenance period on the basis of average end-of-calendar-day balances in the institution’s reserve accounts with its respective national central bank, by comparison with its reserve base (defined set of liabilities of up to two years in the balance sheet of credit institutions).
The volume held by institutions in these accounts in excess of minimum reserve requirements is termed ‘excess reserves’.
How the two-tier system works
Prior to the introduction of tiering, the whole volume of excess reserves was remunerated at an interest rate of 0% or at the deposit facility rate, whichever was lower.
As of October 2019, with the introduction of tiering, part of excess reserves were exempted from negative remuneration at the deposit facility rate (-0.5% at that time) and were remunerated at a rate of 0%.
The non-exempt tier of credit institutions’ excess reserves with the central bank continued to be remunerated at 0% or the deposit facility rate, whichever was lower.
Remuneration of liquidity holdings with the central bank
The volume of exempt excess reserves is determined as a multiple of an institution’s minimum reserve requirements.
The Governing Council has decided to set the initial multiplier to 6 and the interest rate applicable on exempt excess reserves at 0%. At present, the multiplier is set to zero and, as such, there are no exempt excess reserves.
Any adjustment to the multiplier or the interest rate applicable on exempt excess reserves will apply in principle as of the maintenance period following such decision.
Purpose of the system
This system, and in particular the setting of the multiplier applied to minimum reserve requirements (which is the same for all institutions), aims to support the transmission of key interest rates to bank interest rates by mitigating some of the adverse impact on banks’ profitability in an environment of negative interest rates.
Given that the financial benefit of tiering is proportional to the minimum reserve level, credit institutions with a business model relying on the collection of deposits have relatively higher exemption limits. Therefore, associating the two-tier system to the amount of minimum reserve requirements ensures that the system focuses on the institutions that are the main sources of credit to the real economy.