What Is a Reserve Tranche?
A reserve tranche is a portion of the required quota of currency each member country must provide to the International Monetary Fund (IMF) that can be utilized for its own purposes—without a service fee or economic reform conditions.
Reserve Tranche Explained
The IMF is funded through its members and their quota contributions. The reserve tranche is basically an emergency account that IMF members can access at any time without agreeing to conditions or paying a service fee. In other words, a portion of a member country’s quota can be withdrawn free of charge at its own discretion.
- The reserve tranche is a segment of an International Monetary Fund member country’s quota that is accessible without fees or economic reform conditions.
- Initially, member nations’ reserve tranches are 25% of their quota, but this position can change according to any lending that the IMF does with its holdings of the member’s currency.
- The reserve tranches that countries hold with the IMF are considered their facilities of first resort, meaning they will tap into them before seeking a formal credit tranche that charges interest.
Reserve Tranche Requirements
In theory, members can borrow over 100% of their quota. However, 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 with interest. The first 25% reserve tranche portion charges no interest. Anything beyond that could require permission and be subject to a service fee.
Initially, member nations’ reserve tranches are 25% of their quota. However, their reserve tranche position can change according to any lending that the IMF does with its holdings of the member’s currency.
Prior to 1978, the reserve tranche was paid in gold, which was non-interest bearing, and known as the gold tranche.
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. 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.
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 into the reserve tranche before seeking a formal credit tranche.
The SDR was initially defined as equivalent to 0.888671 grams of fine gold—the equivalent to one U.S. dollar at the time—until the collapse of the Bretton Woods fixed exchange rate system.
Special Drawing Rights (SDR)
Contributions to the IMF 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 (USD), the euro (EUR), the Japanese yen (JPY), the pound sterling (GBP) and the Chinese yuan renminbi (CNY). Together, the dollar and euro make up 70% of the basket’s value.
The SDR basket is reviewed every five years, and sometimes earlier if warranted. Reviews take place to ensure that the SDR reflects the relative importance of currencies in the world’s trading and financial systems.