Reserve requirement and excess reserves (deposit facility)

The reserve requirement for banks was established to regulate the liquidity reserves of the financial system. In a currency board arrangement, a sufficient liquidity reserve is the best means of hedging the liquidity risks to the settlement system and the entire financial system. The currency board thus gives a much greater weight to the Estonian reserve instrument, somewhat helping compensate for the lack or limited nature of other instruments.

For these reasons, the 15% rate of the reserve requirement applied in Estonia is higher than in other EU Member States. In order to reduce the negative impact of the high reserve requirement rate on the structure of financial intermediation, the interest margin and service charges, and to adapt the operational framework of monetary policy more to the market situation, reserves deposited with Eesti Pank are subject to the deposit interest rates of the European Central Bank (ECB). In order to create a larger buffer for daily settlements that helps banks reduce the liquidity risk and stabilise the interest rate on the interbank money market, compliance with the reserve requirement is based on the principle of monthly averaging.

So as to reduce potential market distortions while maintaining large liquidity buffers, foreign assets can be used to meet the reserve requirement. It makes no essential difference from the liquidity aspect whether the reserve requirement is met by kroon deposits or high-quality and highly liquid foreign assets. At the same time, market distortions are reduced, since a part of the reserve requirement is met by market instruments. Acceptance of foreign assets as a means of meeting the reserve requirement also helps reduce the level of the minimum reserve of kroons relatively simply, while maintaining sufficient liquidity buffers.