The use of a minimum reserve system by the European System of Central Banks in stage three

8 July 1998

At its meeting on 7 July 1998 the Governing Council of the European Central Bank finalised its recommendation for a Council Regulation (EU) on the application of minimum reserves by the European Central Bank (ECB). This Regulation will set the framework for the main features of any minimum reserve system that may be used by the European System of Central Banks (ESCB) in Stage Three.

At the same meeting, the Governing Council also discussed the actual use and specification of an ESCB minimum reserve system at the start of Stage Three of Monetary Union.

The Governing Council sees three main functions which a minimum reserve system could usefully perform in Stage Three. First, it may contribute to the stabilisation of money market interest rates. Second, such a system will contribute to enlarging the demand for central bank money and thus creating or enlarging a structural liquidity shortage in the market; this is considered helpful in order to improve the ability of the ESCB to operate efficiently as a supplier of liquidity and, in the longer term, to react to new payment technologies such as the development of electronic money. Third, the ESCB's minimum reserve system may also contribute to controlling the expansion of monetary aggregates by increasing the interest rate elasticity of money demand.

The Governing Council attaches particularly high importance to the performance of the first two of these functions, which relate to the management of money markets. Without the use of a minimum reserve system, the ESCB would be faced with a relatively high volatility of money market interest rates, which would require the frequent use of open market operations for fine-tuning purposes. Such a situation would have clear disadvantages in practical terms and could undermine the operational efficiency of monetary policy as central bank signals may become blurred if markets have difficulty in distinguishing policy signals from technical adjustments. By reducing the need for central bank intervention in the market, a minimum reserve system will allow the ESCB to extract valuable information from market developments. Furthermore, the Governing Council regards it as necessary to employ minimum reserves to influence the structural money market situation in the euro area, thereby safeguarding the role of national central banks as providers of liquidity to the banking system.

The Governing Council is conscious that introducing a minimum reserve system has to be seen in the light of the potential burden which it imposes on the private sector and the effects it might have on the financial activity of credit institutions in the euro area. Against this background, the Governing Council intends to implement a minimum reserve system as from the start of Stage Three which will be designed primarily to fulfil the two money market management purposes outlined above, while at the same time allowing an adequate remuneration of minimum reserves.

The following features are foreseen for the ESCB's minimum reserve system:

1. Range of institutions

In accordance with Article 19.1 of the Statute of the ESCB, the ECB will require, at the start of Stage Three, credit institutions (as defined in Article 1 of the First Banking Co-ordination Directive) which are established in the euro area to hold minimum reserves on accounts with the national central banks.

2. Liability base

The ECB intends to include in the reserve base the liability categories "deposits", "debt securities issued" and "money market paper" as defined in its framework for the collection of money and banking statistics. Interbank liabilities and liabilities vis-à-vis the ESCB will not be subject to reserve requirements. Furthermore, a zero reserve ratio will be applied on "repos", "deposits with an agreed maturity of more than two years" and "debt securities with an agreed maturity of more than two years".

3. Reserve ratios

The ESCB will apply a reserve ratio in a range of between 1.5% and 2.5% of the relevant items of the liability base. A ratio in this range is deemed necessary in order to ensure that the desirable money market management functions can be performed. At the same time, such a ratio would be sufficiently low so as not to impose any undesirable rigidity on the asset structure of credit institutions.

4. Lump-sum allowance

The ECB will permit a lump-sum allowance of the order of EUR 100,000 to be deducted from an institution's reserve requirement, so that credit institutions with a small reserve base will not have to hold minimum reserves.

5. Remuneration

The ECB will remunerate minimum reserve holdings at a level corresponding to the rate of its main refinancing operations. In practice, the remuneration will be calculated as the average, over the maintainance period, of the ESCB's rate (weighted according to the number of calendar days) on its main refinancing operations. The remuneration will be paid on the first business day following the end of the maintainance period over which the remuneration was earned.

6. Other features

Further details of the minimum reserve system will be applied as already specified in previous documents published by the European Monetary Institute (EMI), in particular in the report entitled "The single monetary policy in Stage Three: General documentation on ESCB monetary policy instruments and procedures" (September 1997).

The Governing Council intends to decide on the exact specification of the minimum reserve system in November 1998 at the latest. This decision will be based on the early data from the new system for money and banking statistics. It is intended that the precise features of the minimum reserve system will be published in the form of an ECB Regulation

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