RESERVE REQUIREMENT

Today I’d like us to consider the Reserve Requirement (RR). This is one of the policy stances adopted by a nation’s monetary authority to promote and maintain financial stability; by and large, it is adjudged by some as the most effective market instrument, due to its effects on interest rates and borrowings. As renowned economists: Ajayi and Ojo put it, money supply is influenced through reserve ratios than through the monetary base. The reserve requirement is a proportion of deposit liabilities mandated to be set aside as reserves by Deposit Money Banks (DMBs) with the monetary authority in their vault. It could be divided into three a) Cash Reserve Ratio (CRR) b) Liquidity Reserve Ratio (LRR) c) Stabilization securities and special deposits( these both are supplementary reserve requirements) A ratio is fixed by the Monetary Authorities at committee meetings to determine the proportion to be set aside. This ratio is referred to as the reserve requirement ratio. A high reserve requirement ratio has a squeezing effect on the movement of liquid funds (assets and cash) in an economy, through high rate of interest charged by the DMBs and the discouraging effect on borrowing, while a low reserve requirement ratio relaxes the flow of liquidity, encouraging low interest rate and borrowing. In Nigeria, this ratio is fixed at 8% as of July, 2013. What this implies is that for every deposit made, 8% of that deposit should be kept as cash or whatever non-interest bearing asset imposed by the Central Bank. The balance of 92% (which is an asset for the bank) could be used as a loan or investment. Here, it is important to note, that; • if the reserve requirement is held as a non-interest bearing government assets, depositors become financiers of government as well through their deposits • the reserve requirement ratio is applicable to banking financial institutions and not to non-banking financial institutions Indonesia employs the use of government bonds as reserve requirements. The nation in its effort to maintain the value of its currency against inflation (spurred by high fuel costs) is caught at the risk of slow growth through its tightening rates. Consumer prices rose 8.61% in July 2013 after a 5.9% gain in June 2013. The Central Bank of Indonesia boosted its reserves by raising its rate from 2.5% to 4% with a benchmark reference rate of 6.5%. Its move in raising reserve requirements has brought about $4 billion across its banking system. China on the other hand has lowered its reserve rate by 50 basis point to a rate of 20% in May; this is to allow for correction of its recent slow-down in growth. This was commented on by its chief economist at Australia and New Zealand banking group (ANZ) Liu Li-Gang who proposed another cut in June 2103 explaining that the growth momentum of China was weak with a rise in external risk. MATHEMATICAL ANALYSIS R = rD Where: R is the reserve r is the reserve ratio D is deposits Example: a deposit of N200,000 with the existing reserve ratio of 8% would bring about a reserve of R= rD R = 0.08 * 200,000 = N16,000 This means that an 8% reserve ratio would generate a reserve of N16, 000 DANIEL KAYODE-ALLI