On May 16, 2019, the Monetary Board of the Bangko Sentral approved to reduce the reserve requirement ratio (RRR) of the universal and commercial banks by 200 basis points (bps), or from 18 percent to 16 percent, to be implemented in 3 stages: 100 bps effective May 31; 50 bps effective June 28; and 50 bps effective July 26, 2019. The reduction is expected to help mitigate any tightness in domestic liquidity conditions due to limited public expenditure following the budget impasse in the first quarter of the year.
The reduction will release additional liquidity into the market estimated at about P231 billion and according to the Bankers Association of the Philippines this move is appropriate as it would help boost the economy. It was also reported that local equities climbed as investors turned optimistic on the RRR, with the Bureau of Treasury also making a full award in its latest auction for Treasury bills.
The fundamental question is: What is this reserve requirement?
The basic answer is that it refers to the level of reserves the Monetary Board requires banks to maintain against their deposit liabilities. It is the percentage of bank deposits that banks must keep, normally deposited with the Bangko Sentral. It is not available for lending to the public. This means that for every peso of depositors’ money held by banks, 16 centavos (based on the May 31 ratio) are required to be reserved and must not be lent out.
From the depositor’s perspective, it can be taken as a safety net as well as assurance to the depositors that part of their money is secure in the vaults of the Bangko Sentral. It can provide comfort that in case of unusual demand for withdrawals, the reserve can immediately answer that demand to the extent that it is available.
From the point of view of central banking, however, bank reserves are required “in order to control the volume of money created by the credit operations of the banking system” (Sec. 94, RA No. 7653). Under the BSP charter, the requirement for bank reserves is listed under Chapter IV among the “Instruments of Bangko Sentral Action” which seek “to achieve the primary objective of price stability” (Sec. 68, ibid.).
The reserve requirement is a means by which the money supply can be regulated. It influences the level of liquidity in the market and helps steer inflation towards the target level. By raising or lowering the required reserves, available bank credit is either stimulated or tightened, influencing the ability of banks to lend.
To elucidate further, increasing the reserve requirement has a limiting effect on the money supply as banks would need to have more money for keeping and less for lending or investing. It is a clear tightening move by the Bangko Sentral. Conversely, decreasing the reserve requirement is easing because banks will have more money at their disposal. Thus, banks can lend more to the public.
Maintaining the required reserves is subject to strict compliance because the law itself fixes the penalty at one-tenth of one percent (1/10 of 1%) per day on the amount of the deficiency and there cannot be any waiver nor condonation of this penalty except in cases involving: (a) a strike or lockout affecting a bank; (b) a national emergency affecting operations of banks; (c) a rehabilitation program of a bank; or (d) other instances where the waiver is determined by the Monetary Board to be justifiable (Sec. 101, as amended, ibid.).
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