European Monetary System

on a tender procedure. The tender may be a fixed rate tender, with

counterparties bidding amounts, or a floating rate tender, where

counterparties propose bids including both amounts and interest rates.

Second, there is the monthly longer term refinancing operation, which

has a maturity of three months and will always take the form of an interest

rate tender. This is because the ECB will avoid signalling its monetary

policy stance through these particular operations.

The ECB will also conduct fine-tuning operations, through the

national central banks of the euro area or, in exceptional circumstances,

on its own account. Fine tuning operations will be conducted whenever

liquidity or money market conditions warrant. Fine tuning operations may

take the form of reverse repurchase transactions (that is, the same type of

transaction as that used in the main refinancing and the longer term

refinancing operations, but with no pre-set start date nor a pre-set

maturity), foreign exchange swaps or the taking of fixed-term deposits.

Fine tuning operations in the form of reverse repurchase operations may be

executed either through quick tenders or bilaterally. In both cases, these

operations will involve a limited set of eligible counterparties that have

an appropriate track record of activity in the money market. The other

types of fine tuning operations will also be executed with a limited number

of eligible counterparties, which will be selected ex ante by the ECB. In

some countries, there will be a rotation scheme, which will aim at giving

the opportunity to all eligible fine tuning counterparties to participate

in fine tuning operations.

Finally, open market operations may also be conducted whenever

structural reasons, such as the longer-term evolution of liquidity

profiles, warrant it. These so-called structural operations may take the

form of outright purchases or sales of securities or the issuance of debt

certificates by the ECB.

4.2 Standing facilities

The ECB will operate two overnight standing facilities, which will be

available to all credit institutions at national central banks of the euro

area, provided that, when using the marginal lending facility, they have

sufficient collateral. The rate of the marginal lending facility will

constitute the upper bound of collateralised overnight money market rates.

The deposit facility will be remunerated at a rate that will constitute the

lower bound of overnight money market rates.

When using the marginal lending facility, or, for that matter, when

entering in liquidity-providing open market operations in the form of

reverse transactions, counterparties have to post assets with their

national central bank (or the ECB in the exceptional case when the ECB

conducts fine tuning operations on its own account). These assets are meant

to act as guarantees for credits received from the European System of

Central Banks. A list of eligible assets has been drawn up for this

purpose. The list comprises a wide variety of assets and has two sub-sets.

First, the so-called tier one assets, which are selected by the ECB

according to uniform criteria relating to their credit standing in the

whole euro area. Second, the so-called tier two assets, which have been

selected by the ECB because they are of particular importance for certain

national banking systems of the euro area, in order to promote a certain

degree of continuity at the start of the Stage Three of EMU. Two principles

of equal treatment are applied, however. First, the credit standing of tier

two assets is as high as that of tier one assets. Second, both tier one and

tier two assets may be used by any credit institution in the euro area,

irrespective of its location.

In addition, a set of risk control measures has been elaborated to

ensure that, for any counterparty, the amount of assets provided is always

sufficient. Risk control measures cover the assets' price and credit risks,

taking account of the asset type, its characteristics and the maturity of

the transaction. The ECB's risk control measures have been elaborated with

careful attention to the best market practices in this area. They include

the deduction of haircuts from the assets and the imposition of initial

margins to the credit amount. Another feature of the risk control framework

is the regular revaluations of the assets, which will, in most cases, take

place daily and may trigger margin calls, most often to be settled through

delivery of additional assets.

4.3 Minimum reserve system

The ECB will also apply a minimum reserve system to credit

institutions of the euro area. Two main monetary policy objectives have

been assigned to the minimum reserve system. The first objective is to

stabilise money market interest rates through the averaging mechanism,

whereby the fulfilment of minimum reserve requirements is based on average

reserve holdings over monthly periods of time. During the maintenance

period, this allows the banking system to absorb liquidity shocks. The

reduced volatility of money market rates will reduce the need for frequent

fine tuning operations, which will mean that markets are less distorted by

central bank interventions than they would otherwise be. The second

objective of the minimum reserve system is to enlarge the demand for

central bank money, so as to enlarge the liquidity deficit of the banking

system vis-а-vis the ESCB. This will safeguard the role of the European

System of Central Banks as a provider of liquidity to the banking system.

Reserve requirements will be calculated by applying a reserve ratio

of 1.5% to 2.5% to the deposits, debt securities and money market paper

issued by credit institutions, except for residual maturities above two

years. Although repurchase agreements are included in the reserve base,

they will be subject to a zero reserve ratio. In 1999\SCHD-MAY.DOCf[pic]1 T-

-#"+ !-+ 1999\PROT10.DOCfter-bank liabilities and liabilities vis-а-vis

the ESCB will not be subject to reserve requirements. An allowance of the

order of E 100,000 will be deducted from reserve requirements, so that

credit institutions with a small reserve base will not have to hold minimum

reserves.

Reserve holdings will be remunerated up to the required reserve

level, at the rate of the main refinancing operation (as averaged over a

month). It may be argued that a less than full remuneration of minimum

reserves would increase the interest rate elasticity of central bank money

demand. This notwithstanding, the ECB has decided in favour of a full

remuneration of minimum reserves in view of the distortion to efficient

markets that a less than full remuneration would have implied. As a result

of the full remuneration of minimum reserves, the European Central Bank has

also decided not to exempt any credit institution from the minimum reserve

system.

4.4 Procedures

The ECB will have many counterparties and be subject to close public

scrutiny. It has therefore set up procedures for informing its

counterparties and the public about its monetary policy instruments in a

robust and transparent manner.

The ECB will inform its counterparties and the public through a

document detailing its monetary policy instruments and procedures and

through the regular publication of various materials on its Internet site.

General Documentation

The ECB has produced a document describing its monetary policy

instruments and procedures in detail. This is called "General Documentation

on ESCB Monetary Policy Instruments and Procedures". A revised version of

this document was published recently. This revised version includes all the

newly specified elements of the monetary policy framework of the ECB,

including for instance the minimum reserve system. This document also

includes a calendar for the standard tender operations in 1999 (both main

refinancing and longer term refinancing operations). Calendars of standard

tender operations will be published by the ECB every year.

Publications on the ECB's Internet site

The list of assets that are eligible as guarantees for liquidity

providing operations will be made public on the Internet site of the ECB.

The list will be updated on a weekly basis and users will be able to

subscribe to an e-mailing facility for receiving certain designated parts

of the list on a regular basis. Users will also be able to query the list,

which will contain a large number of assets.

The list of institutions subject to minimum reserves, that is, credit

institutions established in the euro area, will also be available on the

Internet site of the ECB, together with the list of all monetary and

financial institutions in the European Union.

5. Concluding remarks

We are less than three months away from the moment when monetary

policy sovereignty is transferred from the NCBs to the ESCB. The bulk of

the preparatory work has already been completed, but major decisions -

above all, the choice of a monetary policy strategy - still have to be

made. The public can be certain that we will always inform them, regularly

and comprehensively, about our considerations and deliberations. We will

make all our decisions transparent. I have no doubt that we will be well

prepared for the moment at which we take over responsibility for monetary

policy in the euro area.

The euro as an international currency

Speech delivered by Eugenio Domingo Solans,

Member of the Governing Council and the Executive Board of the

European Central Bank,

at The Athens Summit '99,

in Athens on 18 September 1999

Thank you for inviting me to the Athens Summit '99 and for giving

me the opportunity to speak to you at this important event.

I should like to share with you my views, and the ECB's views, on

the importance of the euro as an international currency. I understand

that this issue may be of interest to experts from Greece, a "pre-in"

country which intends to join the euro area, and to many participants

from countries outside the euro area and the European Union, some of

which currently have exchange rate regimes related to the euro.

Nowadays the euro is the second most widely used currency in the

world economy, behind the US dollar and ahead of the Japanese yen. As

we all know, any currency fulfils three basic functions: it is a store

of value, a medium of exchange and a unit of account. As a store of

value the use of the euro as an investment and financing currency is

rapidly increasing, as investors understand the advisability of

diversifying their portfolio currencies among those which are more

stable and more internationally used. The euro is developing at a

slower pace as a medium of exchange or payment currency in the

international exchange of goods and services. This fact can easily be

explained by the combined and reinforcing effects of network

externalities and economies of scale in the use of a predominant

international currency as a medium of exchange, as is the case with

the US dollar. The use of the euro as a unit of account is linked to

its use as a store of value and a medium of exchange. The value

stored in euro or the payments made in euro will tend to be counted in

euro.

There are good reasons to expect an increase in international

public use of the euro as a reserve, intervention and pegging

currency, inasmuch as the public authorities understand that it is

worthwhile to allocate their foreign reserves among the main

international currencies and to give the euro a relevant share in

accordance with its internal and external stability and the economic

and financial importance of the euro area.

In connection with the use of the euro as a pegging currency,

approximately 30 countries outside the euro area currently have

exchange rate regimes involving the euro to a greater or lesser

extent. These exchange rate regimes are currency boards (Bosnia-

Herzegovina, Bulgaria, Estonia); currencies pegged to the euro

(Cyprus, the Former Yugoslav Republic of Macedonia and 14 African

countries in which the CFA franc is the legal tender); currencies

pegged to a basket of currencies including the euro, in some cases

with a fluctuation band (Hungary, Iceland, Poland, Turkey, etc.);

systems of managed floating in which the euro is used informally as

the reference currency (Czech Republic, Slovak Republic and Slovenia);

and, last but not least, European Union currencies pegged to the euro

through a co-operative arrangement, namely ERM II. As you well know,

Denmark and Greece joined ERM II on 1 January 1999 with a ±2.25%

fluctuation band for the Danish krone and a ±15% fluctuation band for

the Greek drachma. Although the euro remains in second position after

the US dollar in terms of its official use, the role of the euro will

increase in the future, without a doubt, especially after the year

2002 when the euro banknotes and coins will begin to circulate.

Taking the current situation as a starting point, the

Eurosystem's position concerning the future international role of the

euro is crystal clear: we shall not adopt a belligerent stance in

order to force the use of the euro upon the world economy. We are

convinced that the use of the euro as an international currency will

come about anyway. It will happen spontaneously, slowly but

inexorably, without any impulses other than those based on free will

and the decisions of market participants, without any logic other than

that of the market. In other words, the internationalisation of the

euro is not a policy objective of the Eurosystem; it will neither be

fostered nor hindered by us. The development of the euro as an

international currency will be a market-driven process, a free

process.

The euro fulfils the necessary conditions to be a leading

international currency with the US dollar and not against it. There is

enough room for both currencies in the world economy. The necessary

conditions for a currency to become an international currency are

based on two broad factors: low risk and large size. The low risk

factor is related to the confidence inspired by the currency and its

central bank, which in turn mainly depends on the internal and

external stability of the currency. The low risk factor tends to lead

to diversification among international currencies, since

diversification is a means to reduce the overall risk; it acts, so to

speak, as a centrifugal force. By contrast, the large size factor

relates to the relative demographic economic and financial importance

of the area which supports the currency; in other words, the "habitat"

of the currency. The large size factor, which concerns the

demographic, economic and financial dimension, generally tends to lead

to centralisation around one or a few key international currencies. It

can be seen as a centripetal force, as a virtuous circle, which will

tend to lead to an increasing use of the euro as an international

currency. Let us consider these two factors in more detail.

The first factor concerns low risk, credibility and stability.

The stability of the euro is a priority for the ECB. Compared with the

idea of stability, the strength of the euro is of lesser importance.

This does not mean that the exchange rate of the euro does not

constitute an element to be considered in the second pillar of the

monetary policy strategy of the ECB, which consists of a broadly based

assessment of the outlook for price developments and risks to

stability obtained from a wide range of economic indicators, the euro

exchange rate being one of them. However, the basic factor that will

determine the importance of the euro as a widely used currency in the

world economy, in addition to the demographic, economic and financial

dimensions of the euro area, is, without a doubt, the stability of the

new currency, understood as a means to maintain the purchasing power

of savings.

Stability is the basic requirement for a good currency. It is

what we at the ECB want for the euro. We want a stable euro and we are

convinced that, in the long term, the euro will derive strength from

its stability.

The stability of the euro is the basis for the confidence in and

the credibility of the ECB, without which a large international role

for the euro would be unthinkable. Stability is the proof of the

effectiveness of the institution. Yet in order to be credible it is

not sufficient for the ECB to maintain stability. Other parameters of

its action must be considered: accountability, transparency and

communication, a Europe-wide perspective, etc.

These parameters or conditions for the credibility of the euro

are certainly demanding. However, the achievement of these conditions

is the aim of all those of us who have responsibilities with regard to

the functioning of the Eurosystem.

The second factor, which we have called the large size factor or

the habitat of the euro, is important because without a certain

critical mass, a currency cannot have international relevance, however

high its degree of stability.

The figures relating to the population and the GDP of the euro

area illustrate this. With 292 million inhabitants, its population

exceeds that of the United States (270 million) and that of Japan (127

million). The GDP of the euro area is, on the other hand, equal to 76%

of the GDP of the United States (EUR 5,774 billion compared with EUR

7,592 billion), though it is higher than that of Japan (EUR 3,327

billion). The source of this information, which refers to 1998, is

Eurostat.

However, even more important than the current figures is the

potential for the future development of the euro area, in terms of

population and GDP, if and when the so-called "pre-ins" (Denmark,

Greece, Sweden and the United Kingdom) join the Eurosystem.

The entry of these countries would result in a monetary area of

376 million inhabitants, 39% larger than the United States and almost

triple the size of Japan, with a GDP of EUR 7,495 billion, only

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