Glossary
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Technical terms, unfortunately, cannot always be avoided – particularly when it comes to complex topics such as monetary policy. This is why we have compiled a glossary with a wide range of terms, arranged in alphabetical order and each with a short explanation.
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M1 is the Eurosystem's narrow monetary aggregate and comprises currency in circulation outside the banking system and overnight deposits of non-banks held at monetary financial institutions in the euro area. It also includes overnight deposits denominated in foreign currencies held by euro area residents at monetary financial institutions in the euro area. However, M1 does not comprise deposits held at monetary financial institutions in the euro area which belong to non-residents.
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M2 is the Eurosystem's intermediate monetary aggregate and comprises M1 plus deposits with an agreed maturity of up to and including two years, and deposits redeemable at notice of up to and including three months.
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M3 is the Eurosystem's broad monetary aggregate and comprises M2 plus repurchase agreements, money market fund shares, and debt securities with a maturity of up to and including two years. M3 is a key indicator for the monetary analysis underlying the Eurosystem's monetary policy decisions.
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The Maastricht Treaty (Treaty on European Union) was signed in 1992 and entered into force in 1993. It amended the Treaty establishing the European Community and established the European Union. In particular, it laid the foundations for economic and monetary union. The Maastricht Treaty has since been amended by the Treaty of Amsterdam (1997/1999), the Treaty of Nice (2001/2003) and the Treaty of Lisbon (2007/2009), which brought the provisions of the Maastricht Treaty into line with the prevailing circumstances but did not fundamentally change them.
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The Macroeconomic Imbalance Procedure (MIP) is a surveillance mechanism that aims to prevent and correct macroeconomic imbalances in EU member states by identifying them early on. Macroeconomic imbalances include inter alia high current account deficits or excessive lending growth. Ten scorecard indicators are assessed for every EU member state. If the indicators exceed certain threshold values, the member state in question is subjected to an in-depth country review in order to assess the severity of the imbalances. Depending on the severity of any problematic imbalances identified, the country in question is recommended or obliged to initiate appropriate countermeasures. Countries may ultimately face financial penalties. The MIP is embedded in the European Semester.
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Macroprudential oversight encompasses the functions of those supervisory authorities charged with detecting, assessing and mitigating risks for the financial system as a whole. Macroprudential oversight, with its mandate to influence the entire financial system and the stability thereof, supplements the microprudential oversight of individual banks, insurance corporations and additional participants in the financial system. As part of their macroprudential oversight functions, supervisory authorities can issue warnings about risks and negative developments, and propose ways of averting risk. In Germany, the German Financial Stability Committee (G-FSC) has a pivotal role to play in implementing such measures. Within the G-FSC, the Bundesbank has a number of key tasks, above all monitoring and analysing risks in the German financial system. At European level, the European Central Bank (ECB) is charged with macroprudential oversight as is the European Systemic Risk Board (ESRB).
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Main refinancing operation (MRO) is the term used by the Eurosystem to denote a weekly open market operation with a maturity of one week. The Eurosystem uses MROs to provide central bank money to banks in the form of short-term collateralised loans. MROs are usually conducted as standard tenders; the main refinancing rate resulting from these operations, together with the interest rates for the standing facilities, make up the Eurosystem's key policy rates. The weekly main refinancing operations are usually the Eurosystem’s most important monetary policy instrument, which it uses to steer interest rates and liquidity in the money market and to signal its monetary policy stance. Before the financial crisis, the Eurosystem provided banks with around three quarters of their required central bank liquidity through its main refinancing operations. Since the crisis, the quantitative focus has shifted to long-term refinancing operations.
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A mandate reference is a reference individually assigned by the payee for a direct debit mandate within the Single Euro Payments Area. It may have up to 35 alphanumerical characters and should only ever be issued once. Together with the creditor ID, the mandate reference number is provided to the payer so that they can clearly identify the mandate on which a debit is based and hence check the authorisation for it.
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In futures markets, the term "margin" refers to the collateral or an amount of money which both parties to a futures contract (futures traders) are required to deposit to protect a central counterparty (CCP) against loss. The term "initial margin" refers to the initial deposit to be made when opening a new futures position. If the market price of the underlying futures contract develops adversely for one of the two parties (traders), the "variation margin" is the additional amount which that trader has to deposit to ensure that future payment obligations can be honoured. Futures traders are required to provide the variation margin following a margin call. If the margin call is not met and the CCP does not receive the variation margin by the specified deadline, the CCP closes out the underlying transaction through a counter-transaction at the market conditions prevailing at that time.
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The marginal interest rate is the Eurosystem's term for the lowest interest rate at which central bank money is allotted during a variable rate tender. Bids with lower interest rates are not met. If the demand for central bank money at the marginal interest rate exceeds supply, the allotment volume is divided among the bids by means of a scale-back.
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A monetary policy instrument of the Eurosystem through which banks can obtain overnight liquidity from the central bank on their own initiative — against eligible collateral and at a predetermined interest rate. Banks can cover their short-term liquidity needs using the marginal lending facility. The interest rate for the marginal lending facility generally constitutes the upper limit for the overnight money market rate and is thus one of the Eurosystem's key interest rates.
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Market risk (also known as market price risk) is defined as the risk of an investor experiencing losses if relevant market prices move in a way that is to their own detriment. This may trigger a change in market interest rates in the case of interest-bearing securities, market price fluctuations for securities in general and changes in exchange rates in the case of foreign currencies. Price movements cannot be reliably predicted and are in constant flux. This uncertainty may be reflected in both gains (opportunity) and losses (risk) for market participants. Banks and insurers therefore need to have an appropriate risk management system in place to manage and control the market risks that they take. In order to cover market risk, banks must meet capital requirements so as to maintain a capital buffer to offset any losses
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Microprudential oversight is the supervision of individual institutions. This is the traditional form of banking supervision, which mainly oversees compliance with qualitative (eg risk management) and quantitative (eg minimum capital ratio) requirements at the level of individual institutions. Actors in microprudential oversight are the national supervisory bodies, and at a European level, the three new European supervisory authorities (ESAs) EBA, EIOPA and ESMA. A newer counterpart, developed during the financial crisis, is macroprudential oversight of the entire financial system.
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Microprudential supervision is the supervision of individual institutions. This is the traditional form of banking supervision, which mainly oversees compliance with qualitative (eg risk management) and quantitative (eg capital ratio) requirements at the level of individual institutions. National competent authorities (NCAs) are responsible for the task of microprudential supervision. In Germany, these duties are performed by the Federal Financial Supervisory Authority (BaFin) and the Deutsche Bundesbank. At the European level, this is the task of the Single Supervisory Mechanism (SSM). A newer counterpart to microprudential supervision, developed during the financial crisis, is macroprudential oversight of the entire financial system.
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The Markets in Financial Instruments Directive (MiFID II) works in conjunction with the Markets in Financial Instruments Regulation (MiFIR), which adds detail to the general rules contained in MiFID. Together, MiFID II and MiFIR aim to further the harmonisation of financial markets in the single European market, improve the transparency of financial markets and enhance investor protection. For instance, they require investment advice to be aligned even more closely with market expectations and the investor’s risk profile, and for any recommendations to be suitable and appropriate given the investor’s knowledge and experience. Investment firms must also execute customer orders on terms most favourable for the client (best execution). Measures to increase transparency include requirements to disclose commission payments and keep records of all documentation relating to financial transactions. The costs associated with a particular financial product must also be set out in a transparent manner, which should ultimately bring down trading costs for investors. Furthermore, MiFID II has strengthened consumer protection by giving the European Securities and Markets Authority (ESMA) as well as the European Banking Authority (EBA) the power to prohibit certain financial products.
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The lowest interest rate at which counterparties may submit bids in variable rate tenders.
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The minimum reserve requirement forms part of the Eurosystem's monetary policy toolkit. Banks are required to maintain a certain minimum balance on an account held at their national central bank – ie in central bank money, which only the central bank can create. The minimum reserve amount required is calculated by applying the reserve ratio (currently 1% in the Eurosystem) to certain customer deposits at the banks. The minimum reserve amount does not need to be maintained on a daily basis but as an average over the maintenance period. From 2015, these periods will last six or seven weeks, each starting shortly after the monetary policy meetings of the ECB Governing Council. As the banks do not need to hold the minimum reserve amount on a permanent basis, they can also use it as working capital for their day-to-day payment transactions. Minimum reserves thus act as a buffer in the money market, balancing out strong liquidity swings and steadying interest rate developments. The obligation to maintain minimum reserves means that the banking system has a constant need for central bank money. The central bank meets this demand primarily through refinancing operations. By controlling the interest rate for these transactions, which it sets according to monetary policy criteria, the central bank can influence the interest rate level on the money and capital markets, thereby also steering demand for credit and the creation of deposit money at banks.
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Mobile payments are trifle amount payments made using at least one mobile device, for example mobile phones or tablets.
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A school of thought on monetary policy (main proponent: Milton Friedman) which focuses on keeping monetary growth stable. Monetarists view the regulation of the money supply as the most important factor in monetary policy. They argue that a steadily growing money supply oriented towards expanding production should guarantee price stability. Expanding the money supply too much would lead to inflation, on the other hand.
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Monetary analysis is the second pillar of monetary policy analysis carried out within the Eurosystem. Alongside economic analysis, the Eurosystem uses it to make a comprehensive analysis of risks to price stability. Monetary analysis serves to assess medium to long-term price risks. It is based on the close relationship between the money stock and prices, which has existed for a long time.
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Monetary capital usually denotes an enterprise's near-money assets such as cash and equities. The Deutsche Bundesbank's definition of monetary capital encompasses certain liability items in the consolidated balance sheets of monetary financial institutions which, owing to their long-term character, are not included in the monetary aggregates M1, M2 or M3. Accordingly, monetary capital includes deposits with an agreed maturity of over two years, deposits redeemable at notice of more than three months, debt securities with an original maturity of more than two years and the capital and reserves of monetary financial institutions.
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A financial institution that receives deposits, which are included in the money stock according to the European Central Bank definition, and that grants credit and/or invests in securities. In Germany, banks and money market funds are considered MFIs.
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Monetary policy encompasses all the measures a central bank takes to achieve its objectives, one of which is price stability. To do this, it uses monetary policy instruments to control the interest rates and supply and demand conditions in the money market. The Eurosystem's monetary policy instruments are open market operations, standing facilities and the minimum reserve.
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Monetary policy instruments are the tools the Eurosystem uses to pursue its primary objective of price stability. They include open market operations (main refinancing operations, longer-term refinancing operations, fine-tuning operations, structural operations), standing facilities (marginal lending facility, deposit facility) and the minimum reserve system.
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Monetary policy strategy is the general approach used by central banks to achieve their primary objective – in the Eurosystem, this is price stability. The Eurosystem’s monetary policy strategy comprises two key elements. The first element is a quantitative definition of price stability, which aims to maintain inflation below, but close to, 2%. The second element refers to the two-pillar approach used in the analysis of the risks to price stability. The Eurosystem’s monetary policy strategy provides a framework for explaining monetary policy decisions to the public in a clear and transparent manner. This makes it easier to understand the response pattern of monetary policy to economic developments, and thus to anticipate the broad direction of monetary policy over the medium term. It also helps to stabilise private sector expectations and to reduce fluctuations on the financial markets.
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Monetary targeting is a monetary policy strategy that aims to promote price stability through the intermediate goal of monetary growth. This strategy is closely associated with the name of the Deutsche Bundesbank, which pursued a policy of monetary targeting between 1975 and 1998.
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A group of countries that use a single currency is called a monetary union. Examples of monetary unions are the pan-German Monetary, Economic and Social Union of 1990, and European Economic and Monetary Union (EMU), which was launched in 1999.
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Money is the means of exchange and payment that is generally recognised by a society. If one is legally obliged to accept money, it is deemed to be legal tender which can be used to legally settle a financial obligation. Euro banknotes and coins are legal tender in the euro area. In the Eurosystem, only central banks are allowed to produce and circulate euro banknotes and coins.
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The rise in money supply is called money creation. In the Eurosystem, only central banks can create central bank money, for instance, by granting a loan to a commercial bank or by purchasing an asset from a commercial bank and, in return, crediting the corresponding amount as a sight deposit to an account held with the central bank. Commercial banks can have their sight deposits in central bank money paid out in banknotes and coins - that is in legal tender - and pay this out to their customers in turn. When a commercial bank repays a central bank loan, the corresponding amount is deducted from the sight deposit on its central bank account; this process is called the destruction of money. Commercial banks can only create book money, not central bank money and thus no banknotes or coins. Commercial bank book money is created when a commercial bank grants a loan to or purchases an asset from a non-bank and this non-bank, in return, credits the corresponding amount as a sight deposit. The Eurosystem can influence and control the commercial banks' money creation through its monetary policy instruments. Banking supervision regulations also limit the creation of money by commercial banks.
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In the stricter sense, the money market is where central bank money is traded. Banks use it to balance out short-term liquidity surpluses and shortfalls. The greatest volume of trade is accounted for by "overnight credit", which must be repayed the next day. Banks also agree loans with longer maturities (up to twelve months) via the money market. Refinancing operations concluded between the central bank and banks are also assigned to the money market. In the broader sense, the money market encompasses trade in money market paper. Interbank loans in the money market were previously largely unsecured. Since the beginning of the recent financial crisis, however, many lenders have demanded that borrowers furnish collateral, typically in the form of securities.
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Money market funds invest the funds they receive from investors chiefly in short-term instruments such as bank deposits, variable rate securities and fixed rate securities with a maximum residual maturity of twelve months. Investors can return the investment fund certificates (money market fund shares) sold to them by the money market fund at any time, thereby converting them back into liquidity.
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Money market paper is a short-term debt security with a maturity of up to one year as a rule. In Germany, this traditionally includes government bonds, such as treasury bills and treasury financing paper, but also debt securities with a maturity of less than one year issued by banks (certificate of deposit) and enterprises (commercial paper).
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In general terms, money supply is the stock of money held by non-banks. Money supply is a key economic variable that provides information about future price developments. As there is a fine line between money as a means of payment and money as a store of value, various types of money have been defined. The Eurosystem recognises three monetary aggregates with a decreasing degree of liquidity: M1, M2 and M3; M1 is the most liquid. In addition to the monetary aggregates M1, M2 and M3, experts also consider the amount of central bank money.
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Money trading is the technical banking term used to describe the lending of central bank money in the money market. Money trading usually occurs between banks and consists primarily of short-dated loans, known as overnight money. A disruption to money trading, as a result of uncertainty about the solvency of participating banks for instance, can have a negative impact on interbank liquidity, and in turn, impair the transmission mechanism.
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Monoline insurers are insurance companies which specialise in hedging credit risk.
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The monopoly on the issuing of banknotes refers to the fact that the national central banks are authorised to issue euro banknotes. In the Eurosystem, the exclusive right to issue banknotes is held by the European Central Bank together with the national central banks of the euro-area countries. They put banknotes into circulation via the commercial banks.
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Moral hazard describes a situation in which someone has an incentive to behave immorally, eg irresponsibly. The term originally comes from the field of insurance but is now used in general to describe a system of inappropriate incentives. A typical example of moral hazard is that an insured person will recklessly take on more risks because any damage he or she causes will ultimately be paid for by the insurance company. Bank employees can be exposed to moral hazard if the prospect of receiving a bonus gives them an incentive to grant as many loans as possible while not themselves being personally liable if the bank and its owners face high losses as a result of credit defaults at a later date.
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A mortgage is a right to a piece of land or property which states that the creditor must receive payment of a certain amount to satisfy the claim arising from this right. Mortgages are entered into the Land Register and bound to the claim. If the mortgage holder does not pay back the loaned money as agreed, the creditor can sell the piece of land or property at auction.
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Prior to the entry into force of the German Pfandbrief Act (Pfandbriefgesetz) in 2005, banks authorised to issue Pfandbriefe in Germany were known as mortgage banks.
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A mortgage loan is a long-term loan secured by lien on real property (today predominantly land charges, less commonly mortgages). Mortgage loans are particularly secured by land and buildings.
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A mortgage Pfandbrief is a debt security issued by private mortgage banks and public law credit institutions on the basis of a specific legal framework. Mortgage Pfandbriefe are covered by loans that are collateralised by real estate.
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Securities that are backed by a pool of mortgage loans. They are divided into commercial mortgage-backed securities (CMBS) and residential mortgage-backed securities (RMBS) depending on the type of underlying loan.
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A mutual fund is a special fund managed by an investment company which is invested in assets such as stocks, bonds or real estate. Co-owners of fund assets each hold shares or units in the form of securities (mutual fund shares). By purchasing mutual fund shares, investors can become co-owners of a - typically broadly diversified - portfolio at relatively low cost. Portfolios are broadly diversified in order to mitigate the risk of loss associated with the investment. There is a difference between retail funds (ie funds available to the general public), the shares of which are frequently exchange-traded, and specialised funds, which are created especially for large investors (eg insurance companies).