Conversely, banks whose reserves fall short of their thresholds have an incentive to borrow reserves up to their thresholds at an interest rate below 0.5%, and to deposit these reserves at 0.5% at the SNB. Such a trade, depicted on Slide 7, is beneficial for both types of banks – the bank lending the reserves earns the positive interbank interest rate on its excess reserves, while the bank borrowing the reserves earns the difference between the SNB policy rate and the interbank interest rate. Reserve tiering thus creates an incentive for interbank trading, and thereby supports activity in the interbank money market; this, in turn, ensures a robust basis for the calculation of SARON. 10 To frame this slightly differently: If we did not apply reserve tiering and, instead, remunerated all reserves at the same interest rate, market participants would have little incentive to trade with each other and activity in the Swiss franc money market would decrease drastically as a result. There are two reasons for this. First, most market participants are still flush with reserves. Second, all institutions that have access to the repo market can hold reserves at the SNB. Taken together, there would be little incentive for market participants to attract reserves by engaging in repo transactions, and hence interbank activity would be low. Why does the SNB use reserve absorption? Let us now take a closer look at the second new element of our implementation approach – reserve absorption. Why do we absorb reserves and how do we perform this task?
As we just noted, in our reserve tiering system, banks with excess reserves have an incentive to lend those reserves to banks whose reserves fall short of their thresholds. Unless the borrowing capacity of these banks is substantial, there may still be excess reserves in the system even after all interbank trading is accounted for. This is precisely what we see in the 9  For each bank that is subject to the minimum reserve requirement, the individual threshold corresponds to the moving average of the minimum reserve requirements over the preceding 36 reference periods, multiplied by the applicable threshold factor. The instruction sheet governing interest on sight deposits provides further information. 10 We gained the insight that reserve tiering promotes interbank trading during the time when our policy rate was negative. As we applied a negative interest rate to reserves that exceeded bank-specific exemption thresholds, we were essentially making use of reserve tiering during this period. Fuhrer et al. (2021) investigate monetary policy implementation via reserve tiering both theoretically and empirically. Page 5/10  case shown on Slide 7. Even after factoring in interbank trading, there are still excess reserves, here depicted in light blue. In such an environment, the equilibrium interest rate that would prevail in the interbank money market would be relatively close to the lower remuneration rate on reserves, which is currently 0%.