Excess reserves and excess liquidity

Deposits from credit institutions with the central bank are referred to as reserves. Reserves can be used, amongst other things, to settle payments, provide banknotes and cover the minimum reserve requirements (for further information, see the links below). Excess reserves are deposits by credit institutions on settlement accounts with the central bank that exceed the minimum reserve requirements. Excess reserves are remunerated at 0.00% in the current positive interest rate environment. Instead of holding these reserves on settlement accounts at no interest, credit institutions can place their deposits with the central bank overnight and be remunerated at the deposit rate (see further links). By definition, these balances are not (non-interest-bearing) excess reserves but are referred to as deposit facility balances. Owing to this interest rate differential, excess reserves generally do not play a major role. Only in exceptional cases do banks hold excess reserves, e.g. if they do not have formal access to the deposit facility. The sum of excess reserves and deposits in the deposit facility is referred to as excess liquidity.

Historically, excess liquidity is the result of non-standard monetary policy measures implemented by the Eurosystem since the onset of the banking, financial and sovereign debt crisis since 2007 and the COVID-19 pandemic from 2020. The Eurosystem changed its refinancing operations to fixed rate tenders with full allotment and later launched the APP and PEPP asset purchase programmes as well as targeted longer-term refinancing operations, known as TLTROs. These measures provided the system with more liquidity than needed in purely mathematical terms (e.g. to provide banknotes and to meet minimum reserve requirements). This led to excess liquidity in the banking system.

During the negative interest rate environment, the topic of excess reserves gained media attention. If the interest rate on the deposit facility is negative, excess reserves are subject to negative remuneration as well. On 12 September 2019, the ECB Governing Council agreed on a two-tier system for the remuneration of excess reserves, which came into force with the maintenance period starting on 30 October 2019. Under the new system, which lasted until September 2022, a certain portion of monetary policy counterparties’ excess reserves was remunerated at 0.00% instead of earning negative interest. This portion was linked to the amount of the individual counterparty’s minimum reserve requirements. It was calculated as a multiple of the minimum reserve requirements determined by the ECB Governing Council. The ECB Governing Council also sets the remuneration rate applicable to that amount.

The two-tier system aimed at supporting the bank-based transmission of monetary policy and ensuring that negative interest rates continued to contribute to the accommodative monetary policy stance. Now that the interest rate on the deposit facility has been raised to above zero, the two-tier system for the remuneration of excess reserves is no longer necessary. The ECB Governing Council therefore decided on 8 September 2022 to suspend the two-tier system by setting the above-mentioned multiplier for the minimum reserve requirements to zero with effect from 14 September 2022.