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VoxEU Column Financial Regulation and Banking Monetary Policy

Unremunerated reserves in the Eurosystem, part 2: Tax incidence and deposit relocation risks

Imposing large unremunerated reserves on euro area banks would likely push bank intermediation offshore out of the euro area. This second of two columns recalls the eurodollar market’s experience from the 1970s to 1990 when immobile depositors, rather than bank shareholders or borrowers, bore the burden of such a reserve. Trillions in euro deposits could accordingly relocate to London, leaving smaller, less wealthy depositors to pay the tax. Since depositors would not all sit still for the tax, unremunerated reserve requirements would reduce Eurosystem central bank losses by less than generally estimated.

In the first of this pair of Vox columns, we argued that the Eurosystem’s payment of 4% on €3.6 trillion in excess reserves held by banks in the euro area is not a subsidy. Rather, requiring large unremunerated reserves would amount to a tax on intermediation.

Discussion of this proposal often assumes that bank shareholders would pay the tax (De Grauwe 2023, De Grauwe and Ji 2023a, 2023b, 2023c, 2023d, 2023e, 2023f). That is, banks would repurchase fewer shares, banks would pay smaller dividends, or bank share prices would appreciate less. This is the obverse of the contention that remunerating excess reserves has transferred profits from central banks to commercial banks, profits that arise from the monopoly of money creation (De Grauwe and Ji 2023c). Bank analysts at Standard and Poor’s, a major rating agency, agree that bank profits would suffer (Charnay and Hollegien 2023). Kwapil (2023), for example, is not sure whether bank shareholders, borrowers, or depositors would pay.  

Many participants involved in the debate consider that making bank owners pay is fair. After all, the authorities supported euro area banks in 2008, 2012, and 2020. Banks took then and should now receive less. This would buttress the income of euro area central banks, which are losing money hand over fist holding low yielding bonds. Turnabout is fair play.

This column weighs in on the debate over who would pay: bank shareholders, bank borrowers, or bank depositors. We argue that the evidence of the eurodollar market from the 1970s to 1990 points to the depositor of euros in euro area banks as the likely taxpayer, thanks to bank arbitrage between offshore and onshore deposits. We further argue that businesses and households could shift trillions of euro deposits to London and other offshore centres. Smaller and less wealthy depositors would pay the tax. Since not all depositors would sit still for the tax, it would raise less revenue than its proponents suggest.

We also argue that the imposition of large unremunerated reserves would result in a substantial increase in the share of domestic intermediation by unregulated shadow banks. Ultimately, a further increase in unremunerated reserve requirements must be assessed in terms of its likely impact on the euro area's bank-dominated financial system and its implications for financial stability.

Immobile domestic depositors would likely pay the tax

As De Grauwe and Ji (2023a, 2023d) point out, ceasing to remunerate bank reserves will result in an immediate reduction in bank income. They note that, in the limit, this could imply that “12% of the balance sheet of these credit institutions would be tied up in non-interest-bearing assets” (De Grauwe and Ji 2023d). Lead European bank analysts at Standard and Poor’s, a major rating firm, conclude: “For eurozone banks in aggregate, and all else being equal, we estimate that a one percentage point increase in MRR [(unremunerated) minimum required reserves] could lead to an immediate gross reduction in profit before tax by 3.3%” (Charnay and Hollegien 2023). A ten percentage point hike in required reserves would thus presumably cut euro area commercial bank profits by a third. But the story would not end there.

Banks would then seek to restore their overall interest rate spread and retain their profitability relative to capital. To do so, banks might either increase the rate at which they lend or decrease the rate at which they remunerate deposits. De Grauwe and Ji (2023a, 2023d) mention the first possibility, but not the second. On the one hand, the former would align with the ECB’s strategy to fight inflation. 1
The latter, on the other hand, would run counter to that strategy. Lower deposit rates would discourage saving and encourage consumption (Kwapil 2023).

The general right answer to the question of whether bank depositors, bank borrowers, or bank shareholders would pay the tax is that it depends on the elasticity of deposit versus loan demand (Reinhart and Reinhart 1999). In this case, however, the experience of the eurodollar market over a generation suggests a clear answer to the question of who would pay the tax. Aliber (1980: 513), in an article which has aged as well as its author, put it this way:

A major concern is whether the major beneficiaries of the reduced costs of providing banking services in the offshore market [arising inter alia from the absence of unremunerated reserves] are the depositors, the borrowers, or the intermediaries. In general, the additional interest payment to the depositors is equivalent to the interest-equivalent of the cost of the reserve requirements.

The evidence of the eurodollar market from the 1970s until the Fed lowered the reserve requirement on large domestic certificates of deposit to zero in 1990 strongly points to the conclusion that the domestic depositor pays. 2 That is, immobile domestic depositors paid the tax imposed by required reserves, not shareholders or bank borrowers.

Consistent with Aliber (1980), US and foreign banks responded to the Fed’s unremunerated reserves on time deposits by arbitraging the London and New York dollar markets to equalise the all-in costs of eurodollar deposits and large domestic certificates of deposit. As a result, the benchmark three-month dollar Libor typically exceeded domestic US certificate of deposit yields by the cost of the reserve requirement plus the cost of deposit insurance (Kreicher 1982, McCauley and Seth 1992). Depositors who insisted on depositing in a bank in the US rather than in London or the Caribbean paid for the privilege.

Offshoring euro deposits to London

Would euro area bank depositors sit still for large, unremunerated required reserves? Or would they shift euro deposits to banks outside the euro area? What would prevent ING, Ltd, in London from marketing euro-denominated deposits over the internet to households and firms in the euro area? Recall that such a deposit is not part of the aggregate of deposits in the euro area that is subject to the now unremunerated required reserve (ECB 2002), and that a very large offshore deposit market in euros already exists and does not need to be created. 3 Depositors could command a higher yield without taking any foreign exchange risk and while taking only negligible country risk. 4 At an interest rate of 4% and with a 15% (or 10%) unremunerated reserve, ING could likely offer its internet customers up to 60 (or 40) basis points more on a UK euro deposit than on the same deposit booked in the euro area. 5 Europeans may not have taken to electronic banking as much as the Californians that staged lightning bank runs last March, but they could learn fast with large enough incentives. In addition to such direct marketing of offshore deposits, what would prevent euro SICAVs in France and euro money market funds in Luxembourg from losing their home bias, as did US ‘prime’ money market mutual funds a generation or two ago (Baba et al. 2009)? 

Sixty or 40 basis points is not small change. After the post-crisis Dodd-Frank Act widened the base for the Federal Deposit Insurance Corporation charge of just eight to ten basis points, a half a trillion dollars of US deposits moved from offshore to onshore within months in 2011-12 (Kreicher et al. 2014, McCauley and McGuire 2014). A similar response to the larger tax wedge from a 15% or 10% unremunerated required reserve in the euro area could induce €3-4 trillion of the €15 trillion in reservable deposits in the euro area to shift to London or other centres. As a result, the boost to euro area central banks’ net income – the tax collected – would fall short of projections that presume that euro area depositors would sit still.

The comprehensiveness and timeliness of euro area money and credit statistics would suffer, but greater damage could be done to financial stability. A 60 or 40 basis point wedge would favour not only offshore euro deposits but also onshore nonbank financial intermediation. Banks would lose business to shadow bank competitors with inadequate capital, fair-weather liquidity, and no lender of last resort. While large unremunerated required reserves may be intended to stick it to the banks, bank depositors and the public interest in financial stability could prove to be the big losers.


Depositors of euros in euro area banks would likely bear the cost of large unremunerated reserve requirements. Businesses and upper-income households could easily relocate their euro deposits to jurisdictions at the edge of the euro area that do not pose much legal or country risk. Trillions in euro deposits would relocate to London, leaving smaller, less wealthy depositors to pay the tax. As a result, the projected improvement of euro area central bank income from large unremunerated reserves is likely overstated.

A welfare-optimising level may exist for a positive unremunerated reserve requirement. This level should consider not just the central bank's profit but also the tax’s effects on the euro area banking system's structure and competitiveness. De Grauwe and Ji's (2023d) analysis sidesteps these issues. Further study is warranted on the welfare-optimising level of (un)remunerated reserve requirements.


Aliber, R (1980), “The integration of the offshore and onshore banking system”, Journal of Monetary Economics 6(4): 509–26.

Baba, N, R McCauley and S Ramaswamy (2009), “US dollar money market funds and non-US banks”, BIS Quarterly Review, March: 59-81.

Bank for International Settlements, Monetary and Economic Department (1995), "Financial structure and the monetary policy transmission mechanism", BIS Papers No 0, 15 March.

Charnay, N and P Hollegien (2023), “Eurozone banks: higher reserve requirements would dent profits and liquidity”, SUERF Policy Note 329, December.

De Grauwe, P (2023), “The role of central bank reserves in monetary policy”, Bundesbank Invited Speakers Series, 4 September.

De Grauwe, P and Y Ji (2023a), “Monetary policies that do not subsidise banks”,, 9 January.

De Grauwe, P and Y Ji (2023b), “Monetary policies with fewer subsidies for banks: A two-tier system of minimum reserve requirements”,, 13 March.

De Grauwe, P and Y Ji (2023c), “The extraordinary generosity of central banks towards banks: some reflections on its origin”,, 15 May.

De Grauwe, P and Y Ji (2023d), "Towards monetary policies that do not subsidise banks", Centre for European Policy Studies (CEPS).

De Grauwe, P and Y Ji (2023e), “Unremunerated reserve requirements make the fight against inflation fairer and more effective”,, 7 November.

De Grauwe, P and Y Ji (2023f), “Fighting inflation more effectively without transferring central banks’ profits to banks”, presentation to SUERF BAFFI Bocconi webinar, "Expanding zero-interest minimum reserve requirements: aims, effects, and side-effects", 12 December.

Demski, J and R McCauley and P McGuire (2022), “London as a financial centre since Brexit: evidence from the 2022 BIS Triennial Survey”, BIS Bulletin 65, 16 December.

ECB (2002), “The single monetary policy in the euro area: general documentation on Eurosystem monetary policy instruments and procedures”, April.

Fricke, D, S Greppmair and K Paludkiewicz (2023), “Transmission of interest rate hikes depends on the level of central bank reserves held by banks”,, 30 November.

Kreicher, L (1982), “Eurodollar arbitrage”, Federal Reserve Bank of New York Quarterly Review 7: 10-22.

Kreicher, L, R McCauley and P McGuire (2014), “The 2011 FDIC assessment on banks managed liabilities: interest rate and balance-sheet responses”, in R de Mooij and G Nicodeme (eds), Taxation of the financial sector, Cambridge: MIT Press.

Kwapil, C (2023), “A two-tier system of minimum reserve requirements by De Grauwe and Ji (2023): A closer look”, SUERF Policy Brief 702, October.

McCauley, R (2023a), “Shrinking the Eurosystem’s footprint without offshoring the euro”, SUERF Policy Note 326, November.

McCauley, R (2023b), “Offshoring the euro: London calling?”, FTAlphaville, 9 December.

McCauley, R and P McGuire (2014), “Non-US banks claims on the Federal Reserve”, BIS Quarterly Review, March: 89-97.

McCauley, R and R Seth (1992), “Foreign bank credit to US corporations: the implications of offshore loans”, Federal Reserve Bank of New York Quarterly Review 17: 52–65.

Reinhart, C and V Reinhart (1999), “On the use of reserve requirements in dealing with capital flow problems”, International Journal of Finance & Economics 4(1): 27–54.


  1. Fricke et al (2023) show that banks with larger holdings of excess reserves supply more loans, suggesting that the ECB’s tightening has had less effect owing to the large excess reserves. More generally, the effect of monetary tightening is attenuated by either public sector debt at floating interest rates (which rose with QE) or private sector debt at fixed interest rates (BIS, 1995).
  2. This section draws on McCauley (2023a) and the next on McCauley (2023b).
  3. Putting aside the cross-border deposits within the euro area, London is a larger international banking centre than all the euro area centres combined (Demski et al. 2022). Banks in London report €1.7 trillion in euro-denominated liabilities, mostly to non-banks.
  4. If ING UK holds the counterpart asset as a deposit in ING Amsterdam bank, the latter’s liability would be reservable (ECB 2002). Similarly, in the US case, from 1970 until 1990, net due to positions of US chartered banks to their foreign affiliates were reservable typically at the same rate as large-denomination certificates of deposit (CDs). However, ING could simply rebook loans from Amsterdam to London. If such assets were extraordinarily included in the reserve base, as they were by the Fed, then ING could simply book freshly originated loans in London. In the US case, the eurodollar reserve requirement also included loans made by US-chartered banks’ foreign branches to US residents. But this extraterritorial reach of the reserve requirement was not applied to banks without a US charter, giving foreign-headquartered banks a competitive edge in the US corporate loan market (McCauley and Seth 1992).
  5. That is, .04 X .15 = .006 or .04 X .10 = .004.