All euro area credit institutions are required by the ECB to hold a certain amount of minimum reserves on current accounts with their respective national central banks. The amount of these required minimum reserves is calculated in relation to specific items of banks’ balance sheets, such as deposits with an agreed maturity of up to two years. These items are multiplied by the reserve ratio, which currently stands at 1%.
The main function of the minimum reserve system is to stabilize money market interest rates. Credit institutions must fulfill their reserve requirement not on a daily basis but on average over a longer period of time, the so-called reserve maintenance period. This allows credit institutions to offset temporarily lower balances (arising e.g. from a sudden increase in the demand for banknotes) by higher balances generated on other days within the same maintenance period. Daily compliance with the minimum reserve requirement would force credit institutions to tap the money market to borrow or provide liquidity. This, in turn, would make money market rates increase or decrease. Given the stabilizing role of minimum reserves, the Eurosystem has to intervene less frequently in the money market to stabilize the money market interest rates close to the intended level.
The minimum reserve system is designed to neither put a burden on the banking system nor hinder the efficient allocation of resources. For this reason, credit institutions’ holdings of required reserves are remunerated at a rate that is close to the money market interest rate.