What is a Reserve Tranche
The reserve tranche is portion of the required quota of currency that each International Monetary Fund (IMF) member country must provide to the IMF that can be utilized for its own purposes without a service fee. The reserve tranche portion of the quota can be accessed by the member nation at any time. This is not true for the rest of a member’s quota, of which the member can borrow over 100% but must pay back with interest over a three-year period. Initially member nations’ reserve tranches are 25% of their quota, but their reserve tranche position will change according to any lending that the IMF does with its holdings of the member’s currency.
BREAKING DOWN Reserve Tranche
The reserve tranche is basically an emergency account that IMF members can access without agreeing to conditions or paying a service fee. If the amount being sought by the member nation exceeds its reserve tranche position (RTP), then it becomes a credit tranche that must be repaid in three years. The first 25% reserve tranche portion charges no interest in this case, but there is a service fee if it becomes part of a credit tranche.
Reserve Tranche Function in the International Monetary Fund
The IMF itself is funded through its members and their quota contributions. The contributions are made up of a combination of national currency and special drawing rights (SDR). Because IMF member nations have many different national currencies, the IMF denominates its members' quotas in terms of SDRs, which is an IMF creation backed by a specified basket of major international currencies. As of 2016, the basket currencies for SDRs included the U.S. dollar, the euro, the Japanese yen, the pound sterling and the Chinese yuan. Together, the dollar and euro make up 70% of the basket’s value.
As mentioned, the reserve tranche position increases when the IMF borrows out of a nation’s currency that was gathered as part of the quota. This is because the country whose currency is lent out is considered to be in a creditor position and is remunerated for the use of its funds beyond a portion set out as the unremunerated portion of the reserve tranche. This is simpler than it sounds. Originally the unremunerated portion was in gold that was non-interest bearing, so this practice has been carried forward with the quota portion equal to the gold tranche post 1978. If the IMF is lending out a country’s currency above the unremunerated portion, the amounts above that become additional reserve tranche for the country and are called the country’s remunerated reserve tranche position.
The reserve tranches that countries hold with the IMF are considered their facilities of first resort, meaning they will tap the reserve tranche before seeking a formal credit tranche.