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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 (tiering) aiming to support the bank-based transmission of monetary policy, while preserving the positive contribution of the negative interest rate policy to the accommodative stance of monetary policy. 

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 based on a multiple (currently of six) 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 tiering system entered into force on 30 October 2019.

 

Remuneration of liquidity holdings with the central bank

The two-tier system for remunerating excess reserve holdings

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 account 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 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 tiering 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 interest rate applicable on the deposit facility, whichever was lower. 

As of October 2019, with the introduction of tiering, part of excess reserves have been exempted from negative remuneration at the rate applicable on the deposit facility, currently at -0.5%, and are remunerated at a rate of 0%. 

The non-exempt tier of credit institutions’ excess reserves with the central bank continues to be remunerated at 0% or the deposit facility rate, whichever is lower. 

 

Exempt tier

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 at 6 and the interest rate applicable on exempt excess reserves at 0%. 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 of negative interest rates on banks’ profitability. 

As the financial benefit of tiering 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. 

The calibration adopted seeks to ensure that euro overnight money market rates remain close to levels consistent with the monetary policy stance.