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Box A1. The Mechanics of Tiered Reserve Systems
Banks’ cost of holding central bank liabilities varies with the structure of reserves and their remuneration (Bech and
Malkhozov, 2016). Central banks have historically used tiering regimes to ensure that excess reserves are distributed
widely within the banking sector; they also help protect the interests of domestic retail depositors while attempting to
push as much of the costs onto wholesale (and especially foreign) investors whose deposits contribute mostly to
excess reserves. Thus, the ideal size of the exemption threshold is determined by the amount of domestic retail
funding banks have at the time of the introduction of the system (i.e., the level of deposits central banks want to
protect).
Excess reserves at the ECB, the Swiss National Bank (SNB), and Norges Bank (NB) are held as overnight deposits
whereas the Danmarks Nationalbank (DN) and the Sveriges Riksbank (SR) use a combination of overnight fine-tuning
operations and one-week term deposits to attract reserves and other central bank liabilities above required amounts
(“liquidity surplus”). While the ECB was the first central bank to move its deposit rate significantly into negative
territory, it continues to maintain a single (negative) rate for excess reserves. In contrast, other central banks (BoJ and
SNB)1 have put in place tiered reserve regimes for excess reserves2 to mitigate burdens on bank earnings, facilitate
market transactions (by exploiting the uneven distribution of excess reserves among financial institutions), and
discourage higher holdings of physical currency.3 Excess reserves are partially exempted from the marginal policy
rate for overnight deposits (Denmark and Japan), sight deposit account (Switzerland) or reserve rate balances
(Norway) at the central bank. The two-tier reserve systems in Denmark and Norway were already part of the monetary
policy framework prior to the introduction of negative deposit rates. In the case of Norway, the tiering remains part of
the central bank’s standard liquidity management and was not aimed at shielding excess reserves from negative rates.4
A tiered reserve regime enhances central banks’ capacity to lower the effective policy rate by reducing the direct cost
of negative rates on excess reserves. Exempting a certain amount of excess reserves from the marginal policy rate
avoids imposing the full impact of negative deposit rates on banks. Thus, at the same direct costs to banks, the
marginal policy rate can be lower in a tiered reserve regime. The cost of holding depends on excess reserve holdings
in the tier with the lowest marginal policy rate (i.e., deposit rate). The tiering (and the difference of policy rates in
each tier) determines the extent to which the interest rate of an additional unit of (excess) reserves differs from the
average interest rate for all reserves.
Existing tiered regimes can be broadly categorized based on the number of tiers and the allocation of excess reserves
across these tiers: (i) constant allocation (e.g., Norway and Switzerland), where the exemption threshold for deposits
is specific to each bank (as a fixed multiple of a bank’s required reserves); and (ii) dynamic allocation, where fine-
tuning operations determine the share of excess reserves to be placed with the central bank as more costly overnight
deposits (Sweden), excess deposits (above the aggregate and individual limits for the current account deposits are
converted into certificates of deposit (Denmark),5 or the portion subject to negative rates is designed to increase over
time in line with the monetary base target (Japan). The exemption threshold should be as high as possible to minimize
the banks’ average cost of holding excess reserves while being sufficiently low to transmit the marginal policy rate to
money markets (and increase the opportunity cost of lending rather than depositing cash as reserves with the central
bank). Central banks tend to adjust the tiering over time so that the amount of excess reserves below the exemption
threshold is sufficient to keep money market rates aligned with the marginal policy rate.
1
In Sweden, the SR administers a de facto tiered reserve regime. The marginal policy rate is determined by the central bank’s reserve repo
operations (“market-maintaining repo facility”) while accepting excess reserves as overnight deposits at the repo rate minus 10 bps or as certificates
of deposits, which are issued at the repo rate minus 75 bps for a maturity term of one week. In the case of Norway, the total exemption amount is set
to NOK 45 billion (“total quota”), while the NB has aimed towards keeping the reserves in the banking system at NOK 35 billion (with an interval
of plus/minus NOK 5 billion). As long as excess reserves in the banking system are below this exemption threshold, the overnight rate (NOWA)
remains close to the key policy rate, which is still positive (Bernhardsen and Lund, 2015).
2
A loosely defined tiered reserve system also applies to the ECB, which remunerates overnight deposits in the current account at the MRO rate of 0
percent, effectively exempting about one-seventh of current reserves from the marginal policy rate.
3
Negative interest rates create incentives for banks to hold cash rather than reserves, and for households and non-financial corporates to hold cash
rather than bank deposits. In countries with an even more negative deposit rate than that of the euro area (Denmark, Sweden and Switzerland), cash
in circulation has increased, but growth rates remain within the range seen over the last decade.
4
The NB kept the level of reserves at the normal level and cutting the reserve rate to a negative level just to maintain banks incentive to redistribute
reserves. The short-term money market rate remains positive and close to the key policy rate (sight deposits) in absence of excess reserves in the
system. Only the reserve rate is negative, and with normal liquidity management this rate does not influence the overnight rate.
5
The DN offers one-week certificates of deposit at currently -65 bps and overnight deposits in a current account at currently 0 bps. There are
aggregate limit and individual limits for the current account deposits, which are actively managed by the DN. If the aggregate limit is exceeded by
the end of the day, the excess deposits are converted into certificates of deposit (with a shorter maturity than the usual one-week certificates). Most
recently, it was increased in March 2015 and subsequently lowered in August 2015 and January 2016.