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 remunerating excess reserve holdings aiming to support the bank-based transmission of monetary policy, while preserving its accommodative monetary policy stance.
This system exempts part of credit institutions’ excess reserves with the central bank from negative remuneration at the deposit facility rate. Hence, 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 determined as 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 on 30 October 2019, with the multiplier set at six, and ceased to apply on 27 July 2022, following the Governing Council’s decision to increase the deposit facility rate to a non-negative value. At its meeting on 8 September 2022, the Governing Council decided to suspend this two-tier system setting the multiplier to zero.
Remuneration of liquidity holdings with the central bank when the deposit facility rate is negative
What are excess reserves
The ECB requires credit institutions established in the euro area to hold 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 institutions’ reserve accounts with their respective national central bank, by comparison with their 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 the two-tier system, the whole volume of excess reserves was remunerated at an interest rate of 0% or at the interest rate applicable on the deposit facility, whichever was lower.
As of October 2019, with the introduction of the two-tier system, part of excess reserves have been exempted from negative remuneration at the rate applicable on the deposit facility, -0.5% at the time, and were remunerated at a rate of 0%.
Institutions’ non-exempt excess reserve holdings with the central bank continued to be remunerated at 0% or the deposit facility rate, whichever was lower.
The volume of exempt excess reserves is determined as a multiple of an institution’s minimum reserve requirements.
The Governing Council decided to set the initial multiplier at 6 and the interest rate applicable on exempt excess reserves at 0%. At present, the multiplier is set at zero hence 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 following maintenance period after such decision is made.
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 adverse impacts on banks’ profitability amid negative interest rates.
As the financial benefit of the two-tier system is proportional to the minimum reserve level, credit institutions with a business model relying on the collection of deposits enjoy relatively higher exemption limits. Thus, 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.