Reserve requirement
The reserve requirement (or cash reserve ratio) is a central bank regulation that sets the minimum reserves each commercial bank must hold (rather than lend out) of customer deposits and notes. It is normally in the form of cash stored physically in a bank vault (vault cash) or deposits made with a central bank.
The reserve ratio is sometimes used as a tool in the monetary policy, influencing the country's borrowing and interest rates by changing the amount of loans available[1]. Western central banks rarely alter the reserve requirements because it would cause immediate liquidity problems for banks with low excess reserves; they generally prefer to use open market operations (buying and selling government-issued bonds) to implement their monetary policy. The People's Bank of China uses changes in reserve requirements as an inflation-fighting tool,[2] and raised the reserve requirement ten times in 2007 and eleven times since the beginning of 2010. As of 2006 the required reserve ratio in the United States was 10% on transaction deposits and zero on time deposits and all other deposits.
An institution that holds reserves in excess of the required amount is said to hold excess reserves.
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Effects on money supply
The reserve requirement can affect monetary policy, because the higher the reserve requirement is set, the less money banks will have to loan out, leading to lower money creation, and maintaining the purchasing power of the currency previously in use. The effect is exponential, because money that is loaned out can be re-deposited; a portion of that money may again be re-loaned, and so on. The effect on the monetary supply is governed by the following formula:
rate at which people hold cash (as opposed to depositing it)
the reserve requirement (the percent of deposits that banks are not allowed to lend)
However, in the United States (and other countries except Brazil, China, India, Russia), the reserve requirements are generally not frequently altered to affect monetary policy because of the exponential effect and the large time lag between the implementation of the change and the corresponding effects on inflation.
Required reserves
United States
In the United States, a reserve requirement (or liquidity ratio) is a minimum value, set by the Board of Governors of the Federal Reserve System, of the ratio of required reserves to some category of deposits held at depository institutions (e.g., commercial bank including US branch of a foreign bank, savings and loan association, savings bank, credit union). The only deposit categories currently subject to reserve requirements are net transactions accounts, mainly checking accounts. The total amount of all net transaction accounts held in USA depository institutions, plus US currency held by the nonbank public, is called M1.
A depository institution can satisfy its reserve requirements by holding either vault cash or reserve deposits. An institution that is a member of the Federal Reserve System must hold its reserve deposits at a Federal Reserve Bank. Nonmember institutions can elect to hold their reserve deposits at a member institution on a pass-through basis.[3]
A depository institution's reserve requirements vary by the dollar amount of net transaction accounts held at that institution. Effective December 29, 2011, institutions with net transactions accounts:
- Of less than $10.7 million have no minimum reserve requirement;
- Between $10.7 million and $71.0 million must have a liquidity ratio of 3%;
- Exceeding $71.0 million must have a liquidity ratio of 10%.[4]
The numerical amounts stated above are recalculated annually according to a statutory formula.
Effective December 27, 1990, a liquidity ratio of zero has applied to CDs, savings deposits, and time deposits, owned by entities other than households, and the Eurocurrency liabilities of depository institutions. Deposits owned by foreign corporations or governments are currently not subject to reserve requirements.[5]
When an institution fails to satisfy its reserve requirements, it can make up its deficiency with reserves borrowed either from a Federal Reserve Bank, or from an institution holding reserves in excess of reserve requirements. Such loans are typically due in 24 hours or less.
An institution's overnight reserves, averaged over some maintenance period, must equal or exceed its average required reserves, calculated over the same maintenance period. If this calculation is satisfied, there is no requirement that reserves be held at any point in time. Hence reserve requirements play only a limited role in money creation in the USA.
United Kingdom
The Bank of England holds to a voluntary reserve ratio system, with no minimum reserve requirement set. In theory this means that banks could retain zero reserves, effectively allowing an infinite amount of credit money creation. However, the average cash reserve ratio across the entire United Kingdom banking system is higher, with a 3.1% average as of 1998.
Other countries
Other countries have required reserve ratios (or RRRs) that are statutorily enforced (sourced from Lecture 8, Slide 4: Central Banking and the Money Supply, by Dr. Pinar Yesin, University of Zurich, based on 2003 survey of CBC participants at the Study Center Gerzensee[6]):
| Country | Required reserve (in %) | Note |
|---|---|---|
| Australia | None | Statutory Reserve Deposits abolished in 1988, replaced with 1% Non-callable Deposits[7] |
| Canada | None | |
| New Zealand | None |
1999 [2] |
| Sweden | None | |
| Czech Republic | 2.00 | Since 7 October 2009 |
| Eurozone | 2.00 | Since 1999[8] |
| Hungary | 2.00 | Since November 2008 |
| South Africa | 2.50 | |
| Switzerland | 2.50 | |
| Latvia | 3.00 | Just after the Parex Bank bailout (24.12.2008), Latvian Central Bank decreased the RRR from 7% (?) down to 3%[9] |
| Poland | 3.50 | as of 31 dec 2010 |
| Russia | 4.00 | Effective April 1st 2011, up from 2.5% in January 2011[10]. |
| Chile | 4.50 | |
| India | 6.00 | May 2011, as per RBI. |
| Bangladesh | 6.00 | Raised from 5.50. Effective from 15 December 2010 |
| Lithuania | 6.00 | |
| Pakistan | 5.00 | Since November 1st 2008 |
| Taiwan | 7.00 | [11] |
| Turkey | 8.00 | Since February 1st 2011 |
| Jordan | 8.00 | |
| Zambia | 8.00 | |
| Burundi | 8.50 | |
| Ghana | 9.00 | |
| Israel | 9.00 | the Required Reserve Ratio is called Minimum Capital Ratio[12] |
| Mexico | 10.50 | |
| Sri Lanka | 10.00 | |
| Bulgaria | 10.00 | |
| Croatia | 14.00 | Down from 17%, effective from 2009-01-14[13] |
| Costa Rica | 15.00 | |
| Malawi | 15.00 | |
| Hong Kong | 18.00 | |
| Brazil | 20.00 | Up from 15%, effective from 2010-12-06 - Ratio is for requirement on term deposits.[14] RRR for foreign currency positions increased to 43.00 on 2010 July 15 [3] |
| China | 21.00 | Ratio is for major Chinese Banks on 2011-12-05[15]; it was 21.5% since June 2011. Small and medium-size banks have a lower rate of 19.00%. |
| Tajikistan | 20.00 | |
| Suriname | 25.00 | Down from 27%, effective from 2007-01-01[16] |
| Lebanon | 30.00 | [4] |
Historical changes reserve ratios
In some countries, the cash reserve ratios have decreased over time:[17]
| Country | 1968 | 1978 | 1988 | 1998 |
|---|---|---|---|---|
| United Kingdom | 20.5 | 15.9 | 5.0 | 3.1 |
| Turkey | 58.3 | 62.7 | 30.8 | 18.0 |
| Germany | 19.0 | 19.3 | 17.2 | 11.9 |
| United States | 12.3 | 10.1 | 8.5 | 10.3 |
| India[18] | 3 | 6 | 10 | 10-11 |
(Ratios are expressed in percentage points.)
See also
References
- ^ Central Bank of Russia
- ^ "China moves to cool its inflation". BBC News. 2007-11-11. http://news.bbc.co.uk/1/hi/business/7089307.stm.
- ^ http://www.federalreserve.gov/monetarypolicy/reservereq.htm
- ^ http://www.federalreserve.gov/monetarypolicy/reservereq.htm
- ^ http://www.federalreserve.gov/monetarypolicy/reservereq.htm
- ^ Monetary Macroeconomics by Dr. Pinar Yesin
- ^ "Inquiry into the Australian Banking Industry, Reserve Bank of Australia, January 1991
- ^ <en> European Central Bank, minimum reserve requirements
- ^ "Minimum Reserve Ratio". Bank of Latvia. http://www.bank.lv/eng/main/all/noract/mon_oper/reserve/reserve_ratio_n21. Retrieved 2010-12-29.
- ^ Central bank of Russia Required reserve ratio on credit institutions' liabilities to non-resident has been raised to 4.0%
- ^ Liquidity ratio and liquid reserves of deposit money banks. Data released by Taiwan's central bank in October 2010.
- ^ "Minimum capital ratio". Bank of Israel. http://www.bankisrael.gov.il/deptdata/pikuah/nihul_takin/eng/311_et.pdf. Retrieved 2010-12-29.
- ^ [1] (in Croatian)
- ^ Busines week - Brazil reserve requirement raise
- ^ The People's Bank of China said it would cut the reserve requirement ratio by 0.5 percentage point WSJ, accessdate=2011-12-01
- ^ "Reserve base en Kasreserve". Centrale Bank van Suriname. http://www.cbvs.sr/english/publicaties-reserve.htm. Retrieved 2009-12-21.
- ^ IMF Financial Statistic Yearbook
- ^ http://www.rbi.org.in/scripts/chro_bankrate.aspx Reserve Bank of India
External links
- Title 12 of the Code of Federal Regulations (12CFR) PART 204--RESERVE REQUIREMENTS OF DEPOSITORY INSTITUTIONS (REGULATION D) (See Section §204.4 for current reserve requirements.)
- Reserve Requirements - Fedpoints - Federal Reserve Bank of New York
- Reserve Requirements - The Federal Reserve Board
- Hussman Funds - Why the Federal Reserve is Irrelevant - August 2001
- Don't mention the reserve ratio