Purpose of Imposing Legal Reserve Requirements on Commercial Banks

For example, after the establishment of the Reserve Bank of India, the cash reserve ratio of private banks in India fell from 17.4 per cent in 1935-36 to 9.5 per cent in 1938-39; and in the United States, the ratio (including reserve requirements and interbank deposits) fell from 34% in 1913 to 20% in 1926. See S.N. Sen, Central Banking in Undeveloped Money Markets (Calcutta, 1952), p. 88. The International Banks Act of 1978 required branches of foreign banks operating in the United States to meet the same reserve requirement ratio standards. [8] [9] In the following countries, reserve requirements have changed from time to time (figures in parentheses indicate the number of times): the change in credit and investment of the central bank corresponds to the change in the reserve currency, which is 1E times the change in the total money supply, or c + r (1 – c). The original purpose of secondary reserve requirements was to ensure good banking practice by requiring banks to maintain a minimum level of liquidity. Such laws were introduced in Denmark, Norway, Sweden and Switzerland, mainly in the 1930s, and are still in force. However, the initial minimum ratios were generally low and had little impact on the post-war situation, when banks were in a highly liquid position.

New quotas have been introduced in several countries for the purpose of monetary control. In Switzerland, for example, secondary minimum reserves were used as a monetary policy tool, but retained the form of the original law.16 A liberal interpretation of variable minimum reserves was applied, and the survey covers several countries with legal requirements that were changed at different times. Countries with variable reserve requirements for cash or other assets were considered. Reserve requirements are the amount of cash that banks must have in their vaults or at the nearest Federal Reserve Bank depending on their customers` deposits. Reserve requirements set by the Fed`s Board of Governors are one of the three main instruments of monetary policy – the other two instruments being open market operations and the discount rate. A second method of determining reserve requirements is to link them to deposit rotation; this is sometimes referred to as the speed reserve.12 This method has already been used in Mexico and has recently been discussed in the United States. The aim is to act automatically as a brake on an expansion of the demand for money, which is associated with an increasing speed of deposits in times of boom and high interest rates; The brake is automatically released when the turnover rate decreases with a slowdown in commercial activity and a fall in interest rates. The methodology also has the advantage of avoiding higher reserve requirements, which is possible under a system that differentiates according to the type of deposit or bank. In such a system, minimum reserves can be minimised by shifting deposits from categories with high required ratios to categories with low ratios – for example sight deposits to term deposits or deposits from large urban banks to Landesbanken – without changing the actual nature of the deposit. This was a practical problem of some importance in some countries. The transhipment system allows a reduction in the required reserves only if the lags are effectively associated with a change in the frequency of use of the deposit.

Statutory or customary fixed reserves against deposits have long been used to ensure the liquidity or solvency of commercial banks. These reserves, of course, limit the supply of bank credit and therefore have important implications for monetary policy. However, as long as reserve ratios are not changed by monetary authorities, reserve requirements cannot be actively used as a tool to conduct a stabilizing monetary policy that is flexibly adapted to changing conditions. Over the past two decades, and particularly in the post-war period, the possibilities of variable reserve requirement requirements as a monetary policy tool have been widely recognized, and many countries have given monetary authorities the power to vary reserve requirements relative to commercial bank deposits. However, some countries have adjusted their reserve requirements to reflect small and large fluctuations in the monetary environment. Australia and New Zealand, for example, have frequently adjusted their reserve requirements to reflect changes in the balance of payments situation. Ecuador, Egypt, Greece and New Zealand have adjusted their reserve requirements to reflect seasonal fluctuations in credit demand. In March 1957, however, the Reserve Bank of New Zealand announced that it would try to avoid „substantial and frequent“ changes to this end in the future. The Netherlands has sometimes modified reserve requirements to offset the monetary impact of balance-of-payments changes and to facilitate the listing of government bonds. In the United States, the Federal Reserve authorities refrained from adjusting reserve requirements to daily or seasonal variations in monetary conditions, but reduced requirements during the moderate recessions of 1948-49 and 1953-54, as well as during the more severe recession of 1937-38 and again in 1957-58. High reserve requirements reduce bank yields unless provision is made to allow a return on reserves. It is true that the restriction of credit supply due to reserve requirements can lead to an increase in the interest rates that banks earn on their loans and investments, which could potentially fully offset the impact of a reduction in the volume of credit on banks` profits; However, given the persistence of bank lending rates and their conventional nature in some countries, clearing is likely to be low in most cases.

In addition, other credit restriction measures can also reduce banks` gross profits.7 This is clearly the effect of credit limits. An increase in the central bank`s rediscount rate may limit the ability to cost-effectively on-lend rediscount funds. Open market sales of securities by the central bank may result in lower deposits and income assets of commercial banks (if the sales are made to the non-bank public), or they may involve the replacement of relatively low-yielding government bonds with higher-yielding commercial loans (if the sales are made directly to banks). However, changes in the discount rate and open market operations generally have a more favourable effect on bank profits than changes in reserve requirements or the imposition of credit limits; And they give individual banks more freedom of choice. In the United States, the Douglas Committee recommended in 1950 the extension of reserve requirements to all banks accepting sight deposits, including non-member banks (Report of the Subcommittee on Monetary, Credit, and Fiscal Policies, 81st Cong., 2nd Sess., Washington, 1950, pp. 2-3) and by the Patman Committee in 1952 (Report of the Subcommittee on General Credit Control and Debt Management, 82nd Cong., 2nd Sess., Washington, 1952, 45). Minimum reserves are most often applied to commercial banks as defined in general banking law. Where reserves are required for other financial institutions, the intention generally appears to be to ensure solvency rather than to conduct a general monetary policy. However, some countries have imposed regulations on non-bank financial institutions to control the allocation of their loans and investments, while influencing the overall volume of credit. Recently, several countries have publicly debated whether to extend reserve requirements to financial institutions, which compete directly with commercial banks, given that their liabilities replace bank deposits and their loans and investments are similar to those of banks.

The following list contains the regulatory changes to minimum reserves and indexation of the low reserve bracket and exemption from minimum reserves from 1 December 1959, and their impact on minimum reserves. The argument that high reserve requirements could allow government spending to grow too quickly is based on the assumption that government spending is indeed constrained by the availability of financing, and that without the reserve system, the government could not or would not raise funds through inflationary borrowing from the central bank or tax increases.