Reserve Requirements

11 Key excerpts on "Reserve Requirements"

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  eBook - ePub

  Central Bank Autonomy

  The Federal Reserve System in American Politics

  • Kevin Corder(Author)
  • 2014(Publication Date)
  • Taylor & Francis

    (Publisher)

  CHAPTER 3 Reserve Requirements and the Distribution of Monetary Restraint

  Reserve Requirements specify the percentage of commercial bank liabilities that must be held at the Federal Reserve regional banks in order to meet demands of depositors or other claims against commercial banks. The requirements obligate a financial institution to place funds in a reserve account at a regional Federal Reserve Bank. Since the reserve accounts yield no interest, financial institutions realize no return on bank assets that serve as reserves. Any profits generated by the investment of the contents of these reserve accounts in government securities is held by the Fed, so Reserve Requirements redistribute revenue from commercial banks to the regional Federal Reserve Banks. Required reserves therefore function as an implicit tax on the financial institutions to which they apply.

  Studies of monetary policy outcomes by political scientists and political economists typically have as a singular focus the extent to which central bank policies expand or contract the aggregate supply of credit and money available to finance economic activity. Indicators of expansion and contraction include aggregate nonborrowed commercial bank reserves, the federal funds rate, and the narrow money aggregate (M1). In this context, Reserve Requirements are either high (meaning tighter money) or low (meaning easier money). Little attention is given to variation in the scope and definition of required reserves. This omission is surprising given the distributive implications of changes in Reserve Requirements. Since the structure of Reserve Requirements determines the distribution of an implicit tax burden across types and classes of financial institutions, changes in Reserve Requirements are ultimately redistributive choices. It would seem to matter to both commercial bankers and elected officials whether or not, for instance, bank holdings other than deposits at a Federal Reserve Bank can be counted as cash reserves. Banks that routinely hold large amounts of vault cash, at one time characteristic of rural banks, would be disadvantaged if those assets could not be counted as reserves. Since important redistributive effects accompany changes in Reserve Requirements, these changes should attract considerable attention from members of Congress. Reserve Requirements determine what types of financial institutions are most directly affected by monetary restraint and what types of borrowers face the dearest interest rate premiums when monetary policy is tightened. Elected officials are likely to have preferences over how monetary policy is distributed across the economy, so Reserve Requirements could be a focus of efforts by elected officials to influence monetary policy outcomes. Fed policy makers, reflecting a systematic strategy of avoiding congressional intervention in monetary policy choices, consistently rely on indirect rules and administrative updates (rather than statutory instructions) to manage Reserve Requirements.

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  Federal Reserve Policy Reappraised, 1951–1959

  • Daniel S. Ahearn(Author)
  • 2019(Publication Date)
  • Columbia University Press

    (Publisher)

  In 1948, however, with the support program in force the Federal Reserve simply bought all the bonds offered for sale by banks to raise funds to meet the higher reserve requirement. No crisis was possible under these conditions, but an effective monetary policy was also denied by the sup-port program. 6 For the development of Reserve Requirements in the United States, see, the Federal Reserve Bulletin, XX (November, 1938), 953-72; and Rodkey, Legal Reserves in American Banking. CASH Reserve Requirements 149 the National Banking Act, made no provision for changes in Reserve Requirements. While a fixed legal reserve requirement was aimed at insuring banks' liquidity and solvency, in practice it also served as an aid to credit control since it represented a fulcrum on which central bank actions to release or absorb reserve funds could exert leverage. With a legal reserve requirement, member banks had to react if a restrictive credit policy reduced their reserves below the minimum legal level. Without a legal minimum they might have simply decided to get along with less reserves for awhile and their attitude toward making loans and investments could thus have been unaffected. In the course of time it was recognized that Reserve Requirements could be a powerful lever of credit control as well as a fulcrum. Changes in the requirements which affected the proportion of total reserves that had to be held idle could have just as powerful an effect on banks' ability to lend and invest as open market operations which affected the total of reserve funds. For while a change in percentage requirements in itself neither adds to or subtracts from the total of member bank reserve funds, it does increase or decrease the amount of the total that banks can use and thus increases or diminishes the size of the credit structure and deposit structure that they can erect or maintain on the reserves they hold.

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  Helping the Federal Reserve Work Smarter

  • Leonard Jay Santow(Author)
  • 2016(Publication Date)
  • Routledge

    (Publisher)

  4 Experience with Reserve Requirements Since World War II

  In this chapter I present the history of reserve requirement regulations as far back as 1948 so as to include the many meaningful changes that occurred shortly after the end of World War II. In 1948 the reserve requirement specifications were applied differently, depending on how the Fed characterized a particular group of banks. However, the requirements themselves were relatively simple. Over the more than four decades that followed, the requirements became more complex and subject to a great many changes. In the 1990s the series of changes have brought us to the point where the requirement regulations would not be very effective in preventing banks from becoming overly aggressive in liability management. This may be satisfactory for a time, but limitations on banks' aggression may be necessary before the 1990s are out. Therefore, I continue by describing what is necessary to make the reserve requirement system an effective policy tool for the remainder of this decade. I discuss some questionable recommendations for changes in the system, together with the problems that would be created if the changes were adopted.

  A History of Reserve Requirements: 1948 to the Present

  Reserve Requirements are regulatory methods that can be used to limit or enhance bank credit expansion. By consulting Table 4.1 , showing Reserve Requirements, and Table 4.2 , illustrating the minimum and maximum percentages allowed on required reserves, the reader can get a graphic view of more than forty years of reserve requirement history.

  By the end of 1948, reserve requirement percentages, especially on demand accounts, were near the ceilings allowed. Banks were divided into three requirement categories, based on location and size—central reserve city, reserve city, and country. For the largest banks (central reserve city), the Reserve Requirements on demand accounts were 26 percent; for large banks, primarily regional (reserve city), the requirement was 22 percent; and for country banks, 16 percent. All these banks operated under a reserve requirement on time deposits of 7.5 percent. The dollar amount of requirements, especially on demand accounts, was very high relative to the dollar amount of outstanding bank credit. The primary reason for the high requirements was that, supposedly to combat inflation, the Fed wanted to absorb huge excess reserves created in the 1930s. This inflation fear was evident in the legislation that was passed in 1948.

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  Payment Systems in Global Perspective

  • Maxwell J. Fry(Author)
  • 1999(Publication Date)
  • Taylor & Francis

    (Publisher)

  Chapter 5Reserve Requirements, Liquidity and Risk

  5.1Introduction

  IN RECENT YEARS, REQUIRED RESERVES have been reduced or eliminated in many countries, particularly transitional economies, to remove resource allocation distortions and to counteract financial disintermediation. For example, the ratio of bank reserves to bank deposits fell from over 50 percent to under 20 percent in Estonia, 1991–1996, from 25 to 15 percent in Lithuania, 1993–1995, from 35 to 10 percent in Poland, 1988–1996, from 26 to 18 percent in Russia, 1993–1996, and from 80 to 18 percent in the Ukraine, 1992–1997 (International Financial Statistics, CD-ROM, March 1997).

  To the extent that required reserves can be used during the day for payment purposes, they provide a costless source of liquidity. But noninterest-earning required reserves impose negative effective protection on a country's financial system so encouraging residents to use cheaper financial intermediation services abroad. International competition is therefore forcing monetary authorities to reduce the burden of Reserve Requirements either by lowering ratios or by paying interest on such reserves. At the same time, RTGS systems have been introduced in many industrial, transitional and developing countries both to eliminate settlement risk from high-value payment systems and to reduce moral hazard.

  These two tendencies create potential friction: the former diminishes demand for reserves to be kept overnight and the latter increases demand for reserves during the day. This conflict may encourage banks to spend too much effort from the social welfare viewpoint in managing their reserves. This chapter describes and discusses ways of dealing with these opposing forces, particularly as they apply to transitional and developing countries.

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  The European Monetary Union

  A Commentary on the Legal Foundations

  • Helmut Siekmann(Author)
  • 2021(Publication Date)
  • Hart Publishing

    (Publisher)

  9

  3 The Bundesbank Act in the version valid until the end of 1998 contained rules regarding minimum Reserve Requirements and can be seen as an inspiration for comparable rules contained in Article 19.10 Besides the Deutsche Bundesbank, a number of other central banks of Member States of the Union,11 as well as the Federal Reserve12 and the Bank of Japan,13 used or use minimum Reserve Requirements as a standard monetary policy instrument.14

  4 Article 19.1 (not the competences of the Council pursuant to Article 19.2) can be amended by the simplified amendment procedure according to Article 129.3 TFEU (Article 40.1 Statute).

  B. General Significance

  I. Objectives and Relevance of Minimum Reserve Requirements

  5 Minimum Reserve Requirements are a standard Eurosystem monetary policy tool for the performance of money market management and monetary control functions.15 They aim at stabilising money market interest rates and creating or enlarging a structural liquidity shortage (structural deficit of central bank liquidity).16 By giving institutions an incentive to smooth the effects of temporary liquidity fluctuations, the “average principle”17 of the Eurosystem minimum reserve system supports the stabilisation of money market interest rates.18 The “average principle” also prevents a strong volatility of the overnight rate as it enables institutions to satisfy short-term demands on central bank liquidity with their minimum reserve holdings.19 Minimum Reserve Requirements also ensure the dependency of credit institutions on central bank refinancing operations by increasing the demand for central bank liquidity.20 This demand facilitates the conduction of monetary policy, e.g. to steer money market rates through regular liquidity-providing operations.21 An intended side effect is the increase of the institutions’ liquidity (and solvency) by means of their reserve holdings, even though the banking supervisory law provides increasingly detailed requirements on the institutions’ liquidity ratios.22

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  Reserve Requirements in the Brave New Macroprudential World

  • Tito Cordella, Pablo M. Federico, Carlos A. Vegh, Guillermo Vuletin(Authors)
  • 2014(Publication Date)
  • World Bank

    (Publisher)

  15 Reserve Requirements in the Brave New Macroprudential World http://dx.doi.org/10.1596/978-1-4648-0212-6 This chapter identifies the main stylized facts related to the use of reserve require-ments as a macroeconomic stabilization tool. We first develop an operational definition that will allow us to establish which countries have indeed used Reserve Requirements as a macroeconomic stabilization tool. We then look at the relation between reserve requirement policy (RRP) and monetary policy. Finally, we look at the relation between RRP and foreign exchange market intervention. Which Countries Have Used Reserve Requirements as a Macroeconomic Stabilization Tool? This is the first question that one would like to answer since, unlike monetary or fiscal policy, not all countries may have necessarily used Reserve Requirements to smooth out the business cycle. Answering this question, however, requires some operational definition of what do we mean by using Reserve Requirements as a macroeconomic stabilization tool. The main idea behind our operational defini-tion will be that if the average duration between the changes in reserve require-ments (RR) for any given country is shorter than the average duration of the business cycle in the same country, we will classify that country as having an active RRP. If not, we will classify that country as having a passive RRP. 1 For example, suppose that, on average, a country changes Reserve Requirements every 10 years but the average duration of its business cycle is 3 years. Clearly, such a country is not using Reserve Requirements to influence the business cycle. Conversely, sup-pose that Reserve Requirements are changed every two quarters with the same average duration of the business cycle. In this case, it is very likely that the main purpose of changing Reserve Requirements is to smooth out the business cycle.

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  Economic Areas Under Financial Stability

  • Indranarain Ramlall(Author)
  • 2018(Publication Date)
  • Emerald Publishing Limited

    (Publisher)

  Liquidity reserves fall into the liquidity coverage ratio and the net stable funding ratio under Basel III. The liquidity coverage ratio is expected to be 100% in normal times and allowed to decline during difficult economic conditions. The liquidity coverage ratio captures a bank’s stock of high quality liquid assets over its net cash outflows over the next thirty days and thereby reflects a short-term metric for liquidity position of a bank. The net stable funding ratio is also assumed to be 100% during normal times but captures the long-term liquidity position of a bank as it calculates the proportion of long-term assets which are funded by long-term stable funding. Stable sources of funding can be split into Tier 1 capital, Tier 2 capital, other preferred shares and short-term liabilities such as demand deposits.

  Banks hold not only liquid and capital reserves but they are also obliged by their respective central banks to keep required reserves at the central banks. These reserves can be deemed to form part of liquidity reserves as they are meant to protect the banking sector from declines in liquidity. Some central banks remunerate these reserves while others do not. Interestingly, not all central banks impose Reserve Requirements. Moreover, some banks may keep reserves beyond the stipulated amount at central banks, known as excess reserves. Reserve Requirements are deemed better than interest rate to influence the level of economic activities in an economy. For example, a contractionary monetary policy elicits increases in both deposit and borrowing rates which contribute towards reduced economic activities but at the expense of higher capital inflows attracted by the higher interest rates. These high interest rates can be damaging to an economy which adheres to a fixed exchange rate regime. Reserve Requirements directly help to curtail economic activities without triggering any undesired excessive capital inflows into the economy.

  While both capital reserves and liquidity reserves are of paramount significance to a bank, yet, key differences prevail between them. Capital reserves tend to be more of a long-term nature with the primary aim of averting insolvency of a bank so that the bank can work smoothly even during difficult economic conditions. It can therefore be conjectured that capital reserves are critically important for a bank to mitigate the amplitude of the downward trend of the credit cycle during crisis conditions. Liquidity reserves, though consist of both a long-term and a short-term metrics (net stable funding ratio and liquidity coverage ratio, respectively), tend to be more tilted towards the day-to-day activities of the bank as it sieves out the extent to which assets can be converted into cash. In a nutshell, it can be said that capital reserves ensure the long-term survival of the bank while liquidity reserves ensure the short-term viability state of the bank, making capital reserves and liquidity reserves as complementary tools for financial stability in the banking sector. To bolster financial stability, banks should hold countercyclical assets such as gold whose value scales up during a downturn or a recession and declines during economic booms.

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  Demystifying Global Macroeconomics

  • John E. Marthinsen(Author)
  • 2020(Publication Date)
  • De Gruyter

    (Publisher)

  A $10 million cash withdrawal would reduce the bank ’ s re-serves by $10 million, but its required reserves would fall only by $1 million. As a result, the bank would hold reserves of $90 million, but its required reserves would equal $99 million. 12 Therefore, the bank would be $9 million below the reserves required. The takeaway from this discussion is that the reserve ratio is a monetary tool that allows central banks to control the ability of financial intermediaries to create money. It does not protect banks and depositors from bank runs or provide banks with extra funds to meet extraordinary customer withdrawals. 12 Before the withdrawal, the reserve requirement was 10% of deposits worth $1,000 million, which equaled $100 million. Afterward, they are 10% of deposits worth $990 million, which equals $99 million. Therefore, required reserves fall by only $1 million. Monetary Tools of the Central Bank 211 Interest Return on Bank Deposits (Reserves) at the Central Bank Central banks determine not only the size of the reserve ratio and the particular assets that qualify as reserves but also the interest rate (if any) they give on de-posited bank reserves. Cash that banks hold in their vaults earns no interest, but bank deposits at the central bank may earn a small return. For most of the U.S. Federal Reserve ’ s history, bank deposits at the Fed received no interest, but in 2008, the Fed changed its policy and began paying banks interest on their deposited reserves. 13 Depositing funds at the central bank has one significant advantage, which is the near absence of counterparty risk. Central banks should always be able to repay their obligations — mainly because they can create enough funds to extin-guish their liabilities. Therefore, when a central bank raises the interest it gives on deposited bank reserves, the banking system responds by holding more ex-cess reserves (i.e., they increase the preferred asset ratio, ER/D) and, thereby decrease the money multiplier.

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  Keeping The Central Bank Central

  U.S. Monetary Policy And The Banking System

  • Weir B Brown(Author)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  What is important to recognize is that altering the structure and coverage of the central bank's reserve instrument is an economic policy question to be decided on the basis of whether that would preserve the effectiveness of the Fed's monetary control policy. The matter of the level and distribution of the Reserve Systems' operating profits is not pertinent to that macroeconomic policy question. In stating that the estimated decrease in Treasury receipts was "an 'acceptable' price to pay for being able to deal with the monetary control problem," the Secretary of the Treasury was in effect conceding both the separateness of the two subjects and the superior importance of the monetary policy subject. In addition, the Secretary spoke against the notion that was incorporated in the final MCA of exempting important deposit categories from Reserve Requirements, noting that, in the absence of comprehensive reserve coverage of deposits, "uncontrollable shifts of funds from reservable deposits to non-reservable ones act to weaken the linkage between the reserve base and the money supply." 20 In deciding to revise the structure of Reserve Requirements along the lines described, including the exemption of the bulk of time deposit accounts and certificates, the legislative and monetary authorities appear to have given inadequate attention to developments in the operational behavior of the banking industry and its depositors and to the wider implications of such changes. The Federal Reserve's policy objective of influencing monetary and credit conditions in the U.S. economy is effectuated principally through the banking system

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  Federal Reserve System (central banking system of the United States)

  • (Author)
  • 2014(Publication Date)
  • White Word Publications

    (Publisher)

  The capital requirement ratio is perhaps the most important of these other required ratios. When there are no mandatory Reserve Requirements, the capital requirement ratio acts to prevent an infinite amount of bank lending. ____________________ WORLD TECHNOLOGIES ____________________ Alternative views Seth B. Carpenter and Selva Demiralp have written of their skepticism of the money multiplier mechanism. Also, the idea that the reserve requirement places an upper limit on the money supply is disputed by some economists outside of the mainstream. Notably, theories of endogenous money date to the 19th century, and were subscribed to by Joseph Schumpeter, and later the post-Keynesians. Endogenous money theories postulate that the supply of money is credit-driven and determined endogenously by the demand for bank loans, rather than exogenously by monetary authorities. Money supplies around the world Components of US money supply (currency, M1, M2, and M3) since 1959. In January 2007, the amount of central bank money was $750.5 billion while the amount of commercial bank money (in the M2 supply) was $6.33 trillion. M1 is currency plus demand deposits; M2 is M1 plus time deposits, savings deposits, and some money-market funds; and M3 is M2 plus large time deposits and other forms of money. The M3 data ends in 2006 because the federal reserve ceased reporting it. ____________________ WORLD TECHNOLOGIES ____________________ Components of the euro money supply 1998-2007 Fractional-reserve banking determines the relationship between the amount of central bank money (currency) in the official money supply statistics and the total money supply. Most of the money in these systems is commercial bank money . Fractional reserve banking involves the issuance and creation of commercial bank money, which increases the money supply through the deposit creation multiplier.

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  Introduction to Finance

  Markets, Investments, and Financial Management

  • Ronald W. Melicher, Edgar A. Norton(Authors)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  A financial analyst assesses the short- and long-term financial performance of a government or not-for-profit organization. A financial planner uses financial analysis to develop a financial plan. Education Knowledge of economics and finance is necessary for these jobs, and an understanding of the executive and legislative process is helpful. In addition, a primary way in which government and not-for-profit groups obtain funds is by getting grants. Therefore, strong research and writing skills for grant proposals also are essential. 128 CHAPTER 5 Policy Makers and the Money Supply 5.7 The level of a bank’s excess reserves determines the extent to which deposit expansion (or contrac- tion) takes place. This is true for an individual bank or other depository institution, and for the banking system as a whole. Therefore, the factors that affect the level of bank reserves are significant in deter- mining the size of the money supply. Bank reserves for a depository institution are its vault cash and funds held at its regional Federal Reserve Bank and used to meet Reserve Requirements. Bank reserves for the banking system are the cumulative total of the individual depository institution bank reserves. Bank reserves can be divided into two parts. The first, required reserves, is the minimum amount of reserves that a depository institution must hold against its deposit liabilities. The percentage of deposits that must be held as reserves is called the required reserves ratio. When bank reserves differ from required reserves, a depository institution has either excess reserves or deficit reserves. Excess reserves occur when the amount of a depository institution’s bank reserves exceed required reserves. If required reserves are larger than the bank reserves of an institution, the difference is called deficit reserves.

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