Minimum reservesA monetary policy instrument in the euro area
Minimum reserves are deposits that the European Central Bank (ECB) requires credit institutions to hold with their national central banks. The amount of these reserves is broadly determined by the amount of bank customers’ deposits in the individual credit institution’s balance sheet. The underlying ratio – calculated by the ECB – is the same in all countries of the euro area.
Minimum reserves have been part of the toolbox of the Oesterreichische Nationalbank (OeNB) since December 1, 1955. The national system of minimum reserves remained in force, with several structural adjustments, until December 31, 1998. On January 1, 1999, it was replaced by the Eurosystem’s minimum reserve framework, which equally applies to all countries participating Monetary Union.
Next to discount operations and open market operations, minimum reserves are a standard monetary policy tool in central banking. By imposing minimum reserve requirements, the central bank can steer demand for central bank money and, as a consequence, exert substantial influence on the money market and money market interest rates.
The Eurosystem uses minimum reserves
- to stabilize money market interest rates (by enabling banks to fulfill their reserve requirement on average over a longer period) and
- to tighten or ease liquidity conditions (monetary aggregates) in the money market to enable the ECB to efficiently steer these monetary aggregates.
Of these two functions, the stabilization function plays the bigger role. Banks 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 them to offset temporarily lower balances (arising, e.g., from a sudden increase in the demand for banknotes) by higher balances achieved on other days within the same maintenance period.
If the ECB reduces the reserve ratio, the amounts euro area banks are required to hold with their national central banks decline, which means that more money (liquidity) is available to markets and banks. As a consequence, banks are able to invest more or grant more credit while demand for additional funding drops because the market is saturated; under these conditions, interest rates will fall. If, by contrast, the ECB raises the reserve ratio, banks must hold more minimum reserves with the central bank. Liquidity is withdrawn from the banks, which limits their scope for lending and investment. As a consequence, money in the market – liquidity – becomes scarcer and interest rates will rise as demand goes up.