Reserve requirement

The reserve requirement (or cash reserve ratio) is a central bank regulation employed by most, but not all, of the world's central banks, that sets the minimum amount of reserves that must be held by a commercial bank. The minimum reserve is generally determined by the central bank to be no less than a specified percentage of the amount of deposit liabilities the commercial bank owes to its customers. The commercial bank's reserves normally consist of cash owned by the bank and stored physically in the bank vault (vault cash), plus the amount of the commercial bank's balance in that bank's account with the central bank.

The required reserve ratio is sometimes used as a tool in monetary policy, influencing the country's borrowing and interest rates by changing the amount of funds available for banks to make loans with.[1] Western central banks rarely increase 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, and raised the reserve requirement ten times in 2007 and eleven times since the beginning of 2010.

An institution that holds reserves in excess of the required amount is said to hold excess reserves.

Effects on money supply

Conventional view

The theory that a reserve requirement can be used as a tool of monetary policy is frequently found in economics textbooks. Under the theory, the higher the reserve requirement is set, the less funds banks will have available to lend out, leading to lower money creation and perhaps to higher purchasing power of the money previously in use. Under this view, the effect is multiplied, because money obtained as loan proceeds can be re-deposited, and a portion of those deposits may again be lent out, and so on. Under this theory, the effect on the money supply is governed by the following formulas:

 : definitional relationship between monetary base MB (bank reserves plus currency held by the non-bank public) and the narrowly defined money supply, ,
 : derived formula for the money multiplier m, the factor by which lending and re-lending leads to be a multiple of the monetary base:

where notationally,

the currency ratio: the ratio of the public's holdings of currency (undeposited cash) to the public's holdings of demand deposits; and
the total reserve ratio (the ratio of legally required plus non-required reserve holdings of banks to demand deposit liabilities of banks).

However, in the United States (and other countries except Brazil, China, India, Russia), the reserve requirements are generally not frequently altered to implement monetary policy because of the short-term disruptive effect on financial markets.

Endogenous money view

Some economists dispute the conventional theory of the reserve requirement.[2] Criticisms of the conventional theory are usually associated with theories of endogenous money.

Jaromir Benes and Michael Kumhof of the IMF Research Department report that the "deposit multiplier" of the undergraduate economics textbook, where monetary aggregates are created at the initiative of the central bank, through an initial injection of high-powered money into the banking system that gets multiplied through bank lending, turns the actual operation of the monetary transmission mechanism on its head. Benes and Kumhof assert that in most cases where banks ask for replenishment of depleted reserves, the central bank obliges.[3] Under this view, reserves therefore impose no constraints, as the deposit multiplier is simply, in the words of Kydland and Prescott (1990), a myth. Under this theory, private banks almost fully control the money creation process.[4]

Required reserves

United States

In the United States, a reserve requirement[5] (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 a category of deposit liabilities (called the "Net Transaction Accounts" or "NTAs") owed by depository institutions to their customers (e.g., owed by commercial banks including U.S. branches of a foreign bank, savings and loan association, savings bank, credit union). The deposit liability categories currently subject to reserve requirements are mainly checking accounts. There is no reserve requirement on savings accounts and time deposit accounts owned by individuals.[6] The total amount of all NTAs held by customers with U.S. depository institutions, plus the U.S. paper currency and coin currency held by the nonbank public, is called M1.

A depository institution can satisfy its reserve requirements by holding either vault cash[7] 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.[8]

A depository institution's reserve requirements vary by the dollar amount of NTAs held by customers of that institution. Effective January 18, 2018, institutions with net transactions accounts:

  • Of less than $16 million have no minimum reserve requirement;
  • Between $16 million and $122.3 million must have a liquidity ratio of 3% of NTAs;
  • Exceeding $122.3 million must have a liquidity ratio of 10% of NTAs.[8]

The threshold monetary amounts are recalculated annually according to a statutory formula.

Effective 27 December 1990, a liquidity ratio of zero has applied to CDs 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.[8]

When an institution fails to satisfy its reserve requirements, it can make up its deficiency with reserves borrowed 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 United States. Since quantitative easing began in 2008, they have been even less important, as an enormous glut of excess reserves now exists (over the whole system, though in theory, individual banks may still run into temporary shortfalls).

The International Banking Act of 1978 requires branches of foreign banks operating in the United States to follow the same required reserve ratio standards.[9][10]

Countries without reserve requirements

Canada, the UK, New Zealand, Australia, Sweden and Hong Kong[11] have no reserve requirements.

This does not mean that banks can—even in theory—create money without limit. On the contrary, banks are constrained by capital requirements, which are arguably more important than reserve requirements even in countries that have reserve requirements.

It also does not mean that a commercial bank's overnight reserves can become negative, in these countries. The central bank will always step in to lend the necessary reserves if necessary so that this does not happen; this is sometimes described as "defending the payment system". Historically a central bank might once have run out of reserves to lend and so have had to suspend redemptions, but this can no longer happen to modern central banks because of the end of the gold standard worldwide, which means that all nations use a fiat currency.

A zero reserve requirement cannot be explained by a theory that holds that monetary policy works by varying the quantity of money using the reserve requirement.

Even in the United States, which retains formal (though now mostly irrelevant) reserve requirements, the notion of controlling the money supply by targeting the quantity of base money fell out of favor many years ago, and now the pragmatic explanation of monetary policy refers to targeting the interest rate to control the broad money supply.

United Kingdom

In the UK the term clearing banks is sometimes used, meaning banks that have direct access to the clearing system. However, for the purposes of clarity, the term commercial banks will be used for the remainder of this section.

The Bank of England, which is the central bank for the entire United Kingdom, previously held to a voluntary reserve ratio system, with no minimum reserve requirement set. In theory this meant that commercial banks could retain zero reserves. The average cash reserve ratio across the entire United Kingdom banking system, though, was higher during that period, at about 0.15% as of 1999.[12]

From 1971 to 1980, the commercial banks all agreed to a reserve ratio of 1.5%. In 1981 this requirement was abolished.[12]

From 1981 to 2009, each commercial bank set out its own monthly voluntary reserve target in a contract with the Bank of England. Both shortfalls and excesses of reserves relative to the commercial bank's own target over an averaging period of one day[12] would result in a charge, incentivising the commercial bank to stay near its target, a system known as reserves averaging.

Upon the parallel introduction of quantitative easing and interest on excess reserves in 2009, banks were no longer required to set out a target, and so were no longer penalised for holding excess reserves; indeed, they were proportionally compensated for holding all their reserves at the Bank Rate (the Bank of England now uses the same interest rate for its bank rate, its deposit rate and its interest rate target).[13] In the absence of an agreed target, the concept of excess reserves does not really apply to the Bank of England any longer, so it is technically incorrect to call its new policy "interest on excess reserves".

Canada

Canada abolished its reserve requirement in 1992.[12]

Other countries

Other countries have required reserve ratios (or RRRs) that are statutorily enforced:[14]

Country Required reserve (in %) Note
Australia None Statutory reserve deposits abolished in 1988, replaced with 1% non-callable deposits[15]
New Zealand None

1985[16]

Sweden None Effective 1 April 1994[17]
Eurozone 1.00 Effective 18 January 2012.[18] Down from 2% between January 1999 and January 2012.
Czech Republic 2.00 Since 7 October 2009
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%[19]
Poland 3.50 As of 31 December 2010 [20]
Romania 8.00 As of 24 May 2015 for lei. 10% for foreign currency as of 24 October 2016.[21]
Russia 4.00 Effective 1 April 2011, up from 2.5% in January 2011.[22]
Chile 4.50
India 4.00 June 2 2015, as per RBI.[23]
Bangladesh 6.00 Raised from 5.50, effective from 15 December 2010
Lithuania 6.00
Nigeria 20.00 Raised from 15.00, effective from 25 November 2014[24]
Pakistan 5.00 Since 1 November 2008
Taiwan 7.00 [25]
Turkey 8.50 Since 19 February 2013
Jordan 8.00
Zambia 8.00
Burundi 8.50
Ghana 9.00
Iceland 2.00 [26]
Israel 9.00 The required reserve ratio is called minimum capital ratio.[27]
Mexico 10.50
Sri Lanka 8.00 With effect from 29 April 2011. 8% of total rupee deposit liabilities.
Bulgaria 10.00 Banks shall maintain minimum required reserves to the amount of 10% of the deposit base (effective from 1 December 2008) with two exceptions (effective from 1 January 2009): 1. on funds attracted by banks from abroad: 5%; 2. on funds attracted from state and local government budgets: 0%.[28]
Croatia 14.00 Down from 17%, effective from 14 January 2009[29]
Costa Rica 15.00
Malawi 15.00
Nepal 6.00 From 20 July 2014 (for commercial banks)[30]
Hong Kong None [11]
Brazil 21.00 Term deposits have a 33% RRR and savings accounts a 20% ratio.[31]
China 17.00 China cut bank reserves again to counter slowdown as of 29 February 2016.[32]
Tajikistan 20.00
Suriname 25.00 Down from 27%, effective 1 January 2007[33]
Lebanon 30.00 [34]

Historical changes in reserve ratios

In some countries, the cash reserve ratios have decreased over time; in some countries they have increased:[35]

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[36] 3 6 10 10-11

(Ratios are expressed in percentage points.)

See also

References

  1. ^ "Monetary Policy Aims - Bank of Russia". archive.org. 7 July 2001.
  2. ^ Michael, McLeay. "Money creation in the modern economy" (PDF). Bank of England.
  3. ^ Benes, Jaromir, and Michael Kumhof. The chicago plan revisited. International Monetary Fund, 2012. http://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf
  4. ^ Benes, Kumhof. http://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf
  5. ^ See generally Regulation D, at 12 C.F.R. sec. 204.4 and sec. 204.5
  6. ^ "eCFR — Code of Federal Regulations". www.ecfr.gov.
  7. ^ See 12 C.F.R. sec. 204.2(k).
  8. ^ a b c "The Fed - Reserve Requirements". federalreserve.gov.
  9. ^ Ahorny, Joseph; Saunders, Anthony; Swary, Itzhak (1985). "The Effects of the International Banking Act on Domestic Bank Profitability and Risk". Journal of Money, Credit, and Banking. JSTOR. 17: 493–506. JSTOR 1992444.
  10. ^ "International Banking Act of 1978". Banking Law 101.
  11. ^ a b "Central banks' exit strategies from quantitative easing". Hong Kong Monetary Authority. Retrieved 13 August 2009.
  12. ^ a b c d Jagdish Handa (2008). Monetary Economics (2nd ed.). Routledge. p. 347.
  13. ^ "Sterling Operations - Implementation of Monetary Policy". Bank of England. Retrieved 26 August 2013.
  14. ^ Lecture 8, Slide 4: "Central Banking and the Money Supply" from the presentation Monetary Macroeconomics by Dr. Pinar Yesin, University of Zurich, based on 2003 survey of CBC participants at the Study Center Gerzensee
  15. ^ "Inquiry into the Australian Banking Industry", Reserve Bank of Australia, January 1991
  16. ^ [1]
  17. ^ Lotsberg, Kari "Archived copy" (PDF). Archived from the original (PDF) on 8 December 2015. Retrieved 1 December 2015.CS1 maint: Archived copy as title (link) Penning- & valutapolitik, p. 45-47, 1994:2
  18. ^ Bank, European Central. "How to calculate the minimum reserve requirements". European Central Bank.
  19. ^ "Minimum Reserve Ratio". Bank of Latvia. Retrieved 29 December 2010.
  20. ^ "Narodowy Bank Polski - Internet Information Service". nbp.pl.
  21. ^ "Banca Naţională a României - Reserve requirements". www.bnr.ro.
  22. ^ Central bank of Russia Required reserve ratio on credit institutions' liabilities to non-resident has been raised to 4.0%
  23. ^ [2] ndtv.com
  24. ^ http://businessdayonline.com/2014/11/banks-squeezed-further-as-n40bn-may-vanish-from-industry-wide-profits/#.VHbDB51fqUk
  25. ^ Liquidity ratio and liquid reserves of deposit money banks. Data released by Taiwan's central bank in October 2010.
  26. ^ "Iceland Reserve Requirement Ratio | Economic Indicators". www.ceicdata.com. Retrieved 9 January 2018.
  27. ^ "Minimum capital ratio" (PDF). Bank of Israel. Retrieved 29 December 2010.
  28. ^ "Ordinance No. 21 of the BNB on the Minimum Required Reserves Maintained with the Bulgarian National Bank by Banks" (PDF). Bulgarian National Bank.
  29. ^ Decision on Reserve Requirements, Croatian National Bank (in Croatian)
  30. ^ "Nepal Rastra Bank". www.nrb.org.np.
  31. ^ "Circular 3.632" (PDF). bcb.gov.br.
  32. ^ CNBC (29 February 2016). "China central bank cuts reserve requirement ratio". cnbc.com.
  33. ^ "Reserve base en Kasreserve". Centrale Bank van Suriname. Retrieved 21 December 2009.
  34. ^ "Lebanon 'immune' to financial crisis". 5 December 2008 – via news.bbc.co.uk.
  35. ^ IMF Financial Statistic Yearbook
  36. ^ Chronology of Bankrate, CRR and SLR Changes Archived 29 August 2011 at the Wayback Machine, Reserve Bank of India

External links

Bank regulation

Bank regulation is a form of government regulation which subjects banks to certain requirements, restrictions and guidelines, designed to create market transparency between banking institutions and the individuals and corporations with whom they conduct business, among other things. As regulation focusing on key actors in the financial markets, it forms one of the three components of financial law, the other two being case law and self-regulating market practices.Given the interconnectedness of the banking industry and the reliance that the national (and global) economy hold on banks, it is important for regulatory agencies to maintain control over the standardized practices of these institutions. Supporters of such regulation often base their arguments on the "too big to fail" notion. This holds that many financial institutions (particularly investment banks with a commercial arm) hold too much control over the economy to fail without enormous consequences. This is the premise for government bailouts, in which government financial assistance is provided to banks or other financial institutions who appear to be on the brink of collapse. The belief is that without this aid, the crippled banks would not only become bankrupt, but would create rippling effects throughout the economy leading to systemic failure. Compliance with bank regulations is verified by personnel known as bank examiners.

Bank run

A bank run (also known as a run on the bank) occurs when a large number of people withdraw their money from a bank, because they believe the bank may cease to function in the near future. In other words, it is when, in a fractional-reserve banking system (where banks normally only keep a small proportion of their assets as cash), a large number of customers withdraw cash from deposit accounts with a financial institution at the same time because they believe that the financial institution is, or might become, insolvent; they keep the cash or transfer it into other assets, such as government bonds, precious metals or gemstones. When they transfer funds to another institution, it may be characterized as a capital flight. As a bank run progresses, it generates its own momentum: as more people withdraw cash, the likelihood of default increases, triggering further withdrawals. This can destabilize the bank to the point where it runs out of cash and thus faces sudden bankruptcy. To combat a bank run, a bank may limit how much cash each customer may withdraw, suspend withdrawals altogether, or promptly acquire more cash from other banks or from the central bank, besides other measures.

A banking panic or bank panic is a financial crisis that occurs when many banks suffer runs at the same time, as people suddenly try to convert their threatened deposits into cash or try to get out of their domestic banking system altogether. A systemic banking crisis is one where all or almost all of the banking capital in a country is wiped out. The resulting chain of bankruptcies can cause a long economic recession as domestic businesses and consumers are starved of capital as the domestic banking system shuts down. According to former U.S. Federal Reserve chairman Ben Bernanke, the Great Depression was caused by the Federal Reserve System, and much of the economic damage was caused directly by bank runs. The cost of cleaning up a systemic banking crisis can be huge, with fiscal costs averaging 13% of GDP and economic output losses averaging 20% of GDP for important crises from 1970 to 2007.Several techniques have been used to try to prevent bank runs or mitigate their effects. They have included a higher reserve requirement (requiring banks to keep more of their reserves as cash), government bailouts of banks, supervision and regulation of commercial banks, the organization of central banks that act as a lender of last resort, the protection of deposit insurance systems such as the U.S. Federal Deposit Insurance Corporation, and after a run has started, a temporary suspension of withdrawals. These techniques do not always work: for example, even with deposit insurance, depositors may still be motivated by beliefs they may lack immediate access to deposits during a bank reorganization.

British Banking School

The British Banking School was a group of 19th century economists from the United Kingdom who wrote on monetary and banking issues. They were created to oppose the British Currency School; they argued that currency issue could be naturally restricted by the desire of bank depositors to redeem their notes for gold. According to Jacob Viner the main members of the Banking School were Thomas Tooke, John Fullarton, James Wilson, and J. W. Gilbart. They believed "The amount of paper notes in circulation was adequately controlled by the ordinary processes of competitive banking, and if the requirement of convertibility was maintained, could not exceed the needs of business for any appreciable length of time". Thus they opposed the requirement in the Bank Act of 1844 for a reserve requirement on banknotes.

CRR

CRR may refer to:

Capital Requirements Regulation, a European regulation on prudential requirements for credit institutions and investment firms

Coefficient of residuals resistance, (in Statistics) a random measurement on residuals in piecewise regression analysis

Convergence rate of residuals, (in Statistics) an alternative term with the same meanings as the coefficient of residuals resistance

Reserve requirement or cash reserve ratio

Binomial options pricing model or Cox Ross Rubinstein option pricing model

Clinchfield Railroad

Carolina Algonquian language (ISO 639-3 language code)

The Center For Reproductive Rights

The Current Run Rate (Cricket)

Curia Regis roll

Central Bank of Myanmar

The Central Bank of Myanmar (Burmese: မြန်မာနိုင်ငံတော်ဗဟိုဘဏ်; MLCTS: myan ma naing ngam taw ba ho bhan IPA: [mjəmà nàinŋàndɔ̀ bəhòʊbàn]; abbreviated CBM) is the central bank of Myanmar (formerly Burma).

Excess reserves

In banking, excess reserves are bank reserves in excess of a reserve requirement set by a central bank.In the United States, bank reserves for a commercial bank are held in part as a credit balance in an account for the commercial bank at the applicable Federal Reserve bank (FRB). This credit balance is not separated into separate "minimum reserves" and "excess reserves" accounts. The total amount of FRB credits held in all FRB accounts for all commercial banks, together with all currency and vault cash, form the M0 monetary base. Holding excess reserves has an opportunity cost if higher risk-adjusted interest can be earned by putting the funds elsewhere. For banks in the U.S. Federal Reserve System, this earning process is accomplished by a given bank in the very short term by making short-term (usually overnight) loans on the federal funds market to another bank that may be short of its reserve requirements. Over longer periods, banks have the opportunity to choose how much to hold in excess reserves versus in loans to the non-bank public. Therefore, the amount of its assets that a bank chooses to hold as excess reserves is a decreasing function of the amount by which the market rate for loans to the non-bank public from banks exceeds the interest rate on excess reserves and of the amount by which the federal funds rate exceeds the interest rate on excess reserves. Even with a substantial opportunity cost, banks may choose to hold some excess reserves to facilitate upcoming transactions or to meet contractual clearing balance requirements.

Federal funds rate

In the United States, the federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight, on an uncollateralized basis. Reserve balances are amounts held at the Federal Reserve to maintain depository institutions' reserve requirements. Institutions with surplus balances in their accounts lend those balances to institutions in need of larger balances. The federal funds rate is an important benchmark in financial markets.The interest rate that the borrowing bank pays to the lending bank to borrow the funds is negotiated between the two banks, and the weighted average of this rate across all such transactions is the federal funds effective rate.

The federal funds target rate is determined by a meeting of the members of the Federal Open Market Committee which normally occurs eight times a year about seven weeks apart. The committee may also hold additional meetings and implement target rate changes outside of its normal schedule.

The Federal Reserve uses open market operations to make the federal funds effective rate follow the federal funds target rate. The target rate is chosen in part to influence the money supply in the U.S. economy

Fi-linx

fi-linx (intentionally lower-case) is a Credit Union Service Organization owned by Maps Service Agency, a subsidiary of Maps Credit Union, and headquartered in Salem, Oregon. A financial software development company, fi-linx products are specifically marketed to credit unions. The company has been featured in credit industry related publications such as the Credit Union Times and the Credit Union Journal and their services are offered both directly and through the Credit Union Executives Society (CUES).

Full-reserve banking

Full-reserve banking (also known as 100% reserve banking) is a proposed alternative to fractional-reserve banking in which banks would be required to keep the full amount of each depositor's funds in cash, ready for immediate withdrawal on demand. Funds deposited by customers in demand deposit accounts (such as checking accounts) would not be loaned out by the bank because it would be legally required to retain the full deposit to satisfy potential demand for payments. Proposals for such systems generally do not place such restrictions on deposits that are not payable on demand, for example time deposits.Monetary reforms that included full-reserve banking have been proposed in the past, notably in 1935 by a group of economists, including Irving Fisher, as a response to the Great Depression. More recently, there has been renewed interest following the Great Recession.Currently, no country in the world requires full-reserve banking. Banks operating under a full-reserve ratio generally do so by choice or by contract, although the governments in some countries such as Iceland and the US have considered implementing full reserve banking to avoid future financial crises. In 2018, Switzerland voted on the Sovereign Money Initiative which has full reserve banking as a prominent component of its proposed reform of the Swiss monetary system. The measure was overwhelmingly rejected.

Leverage (finance)

In finance, leverage (sometimes referred to as gearing in the United Kingdom and Australia) is any technique involving the use of debt (borrowed funds) rather than fresh equity in the purchase of an asset, with the expectation that the after-tax profit to equity holders from the transaction will exceed the borrowing cost, frequently by several multiples⁠ ⁠— hence the provenance of the word from the effect of a lever in physics, a simple machine which amplifies the application of a comparatively small input force into a correspondingly greater output force. Normally, the lender (finance provider) will set a limit on how much risk it is prepared to take and will set a limit on how much leverage it will permit, and would require the acquired asset to be provided as collateral security for the loan. For example, for a residential property the finance provider may lend up to, say, 80% of the property's market value, for a commercial property it may be 70%, while on shares it may lend up to, say, 60% or none at all on certain volatile shares.

Leveraging enables gains to be multiplied. On the other hand, losses are also multiplied, and there is a risk that leveraging will result in a loss if financing costs exceed the income from the asset, or the value of the asset falls.

Liquidity ratio

Liquidity ratio may refer to:

Reserve requirement, a bank regulation that sets the minimum reserves each bank must hold.

Quick ratio (also known as an acid test or liquidity ratio), a ratio used to determine the liquidity of a business entityLiquidity ratio expresses a company's ability to repay short-term creditors out of its total cash. It is the result of dividing the total cash by short-term borrowings. It shows the number of times short-term liabilities are covered by cash. If the value is greater than 1.00, it means fully covered.

The formula is the following:

LR = liquid assets / short-term liabilities

Monetary policy

Monetary policy is the process by which the monetary authority of a country, typically the central bank or currency board, controls either the cost of very short-term borrowing or the money supply, often targeting inflation or the interest rate to ensure price stability and general trust in the currency.Further goals of a monetary policy are usually to contribute to the stability of gross domestic product, to achieve and maintain low unemployment, and to maintain predictable exchange rates with other currencies.

Monetary economics provides insight into how to craft an optimal monetary policy. In developed countries, monetary policy has been generally formed separately from fiscal policy, which refers to taxation, government spending, and associated borrowing.Monetary policy is referred to as being either expansionary or contractionary. Expansionary policy occurs when a monetary authority uses its tools to stimulate the economy. An expansionary policy maintains short-term interest rates at a lower than usual rate or increases the total supply of money in the economy more rapidly than usual. It is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that less expensive credit will entice businesses into expanding. This increases aggregate demand (the overall demand for all goods and services in an economy), which boosts short-term growth as measured by gross domestic product (GDP) growth. Expansionary monetary policy usually diminishes the value of the currency relative to other currencies (the exchange rate).The opposite of expansionary monetary policy is contractionary monetary policy, which maintains short-term interest rates higher than usual or which slows the rate of growth in the money supply or even shrinks it. This slows short-term economic growth and lessens inflation. Contractionary monetary policy can lead to increased unemployment and depressed borrowing and spending by consumers and businesses, which can eventually result in an economic recession if implemented too vigorously.

Monetary policy of the United States

Monetary policy concerns the actions of a central bank or other regulatory authorities that determine the size and rate of growth of the money supply. For example, in the United States, the Federal Reserve is in charge of monetary policy, and implements it primarily by performing operations that influence short-term interest rates.

Money multiplier

In monetary economics, a money multiplier is one of various closely related ratios of commercial bank money to central bank money (also called the monetary base) under a fractional-reserve banking system. In one version it measures the maximum amount of commercial bank money that can be created, given a certain amount of central bank money and ignoring leakages into currency held by the non-bank public. That is, in a fractional-reserve banking system, the total amount of loans that commercial banks are allowed to extend (the commercial bank money that they can legally create) when there are no leakages is equal to a multiple of the amount of reserves. This multiple is the reciprocal of the reserve ratio, and it is an economic multiplier. The actual ratio of money to central bank money, also called the money multiplier, is lower because some funds are held by the non-bank public as currency and most banks hold excess reserves (reserves above the amount required by the central bank)

Although the money multiplier concept is a traditional portrayal of fractional reserve banking, it has been criticized as being misleading. The Bank of England and the Standard & Poor's rating agency (amongst others) have issued detailed refutations of the concept together with factual descriptions of banking operations. Several countries (such as Canada, the UK, Australia and Sweden) set no legal reserve requirements. Even in those countries that do (such as the USA), the reserve requirement is as a ratio to deposits held, not a ratio to loans that can be extended. Basel III does stipulate a liquidity requirement to cover 30 days net cash outflow expected under a modeled stressed scenario (note this is not a ratio to loans that can be extended); however, liquidity coverage does not need to be held as reserves but rather as any high-quality liquid assets

In equations, writing M for commercial bank money (loans), R for reserves (central bank money), and RR for the reserve ratio, the reserve ratio requirement is that the fraction of reserves must be at least the reserve ratio. Taking the reciprocal, which yields meaning that commercial bank money is at most reserves times the latter being the multiplier ignoring leakages into currency.

If banks lend out close to the maximum allowed by their reserves and there are no leakages into currency holdings, then the inequality becomes an approximate equality, and commercial bank money is central bank money times the multiplier. If banks instead lend less than the maximum, accumulating excess reserves, then commercial bank money will be less than central bank money times the theoretical multiplier.

Overnight policy rate

The overnight policy rate is an overnight interest rate set by Bank Negara Malaysia (BNM) used for monetary policy direction. It is the target rate for the day-to-day liquidity operations of the BNM. The overnight policy rate (OPR) is the interest rate at which a depository institution lends immediately available funds (balances within the central bank) to another depository institution overnight. The amount of money a bank has fluctuates daily based on its lending activities and its customers’ withdrawal and deposit activity, therefore the bank may experience a shortage or surplus of cash at the end of the business day. Those banks that experience a surplus often lend money overnight to banks that experience a shortage so the banking system remains stable and liquid. This is an efficient method for banks around the world to practice 'Accessing short-term financing' from the central bank depositories. The interest rate of the OPR is influenced by the central bank, where it is a good predictor for the movement of short-term interest rates. In 2014, Malaysia’s central bank raised its key interest rate for the first time in more than three years, to help temper inflation and rising consumer debt.In Malaysia, changes in the OPR trigger a chain of events that affect the base lending rate (BLR), short-term interest rates, fixed deposit rate, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output, and prices of goods and services which is the micro and macro factors on the economic. The new base rate (BR) framework encourages greater transparency from banks and will enable customers to make better financial decisions. Previously, calculations of BLR lacked transparency and some banks were lending below the BLR to attract customers and boost loan growth. Under the new system, customers cannot borrow below the base rate. The BLR is usually adjusted at the time in correlation to the adjustments of the OPR which is determined by Bank Negara Malaysia during one its monetary policy meetings.With the new BR, interest rates are determined by the banks’ benchmark cost of funds and Statutory Reserve Requirement (SRR). Other components of loan pricing such as borrower credit risk, liquidity risk premium, operating costs and profit margin will be reflected in a spread in the new BR framework.

People's Bank of China

The People's Bank of China (PBC or PBOC; Chinese: 中国人民银行; pinyin: Zhōngguó Rénmín Yínháng) is the central bank of the People's Republic of China responsible for carrying out monetary policy and regulation of financial institutions in mainland China, as determined by People's Bank Law and Commercial Bank Law. Valued at US$3.21 trillion, The People's Bank of China has had the largest financial asset holdings of any central bank in the world since July 2017. Though possessing a high degree of independence by Chinese standards, it remains a department of the State Council.

Regulation D (FRB)

Reserve Requirements for Depository Institutions (12 C.F.R. 204, Regulation D) is a Federal Reserve regulation which sets out reserve requirements for banks in the United States. It is more familiar to the public as the regulation that limits monthly withdrawals from savings accounts.

Statutory liquidity ratio

Statutory liquidity ratio (SLR) is the Indian government term for the reserve requirement that the commercial banks in India are required to maintain in the form of cash, gold reserves, RBI approved securities before providing credit to the customers. Statutory liquidity ratio is determined by Reserve Bank of India maintained by banks in order to control the expansion

The SLR is determined by a percentage of total demand and time liabilities. Time liabilities refer to the liabilities which the commercial banks are liable to pay to the customers after a certain period mutually agreed upon, and demand liabilities are such deposits of the customers which are payable on demand. An example of time liability is a six month fixed deposit which is not payable on demand but only after six months. An example of demand liability is a deposit maintained in a saving account or current account that is payable on demand through a withdrawal form such as a cheque.

The SLR is commonly used to control inflation and fuel growth, by increasing or decreasing it respectively. This counter acts by decreasing or increasing the money supply in the system respectively. Indian banks’ holdings of government securities are now close to the statutory minimum that banks are required to hold to comply with existing regulation. When measured in rupees, such holdings decreased for the first time in a little less than 40 years (since the nationalisation of banks in 1969) in 2005–06. Currently it is 19 percent.

Time deposit

A time deposit or term deposit (also known as a certificate of deposit in the United States) is an interest-bearing bank deposit with a specified period of maturity. It is a money deposit at a banking institution that cannot be withdrawn for a specific term or period of time (unless a penalty is paid). When the term is over, it can be either withdrawn or held for another term. Generally speaking, the longer the term, the better the yield on the money.

The opposite, sometimes known as a call deposit or sight deposit, is a deposit that can be withdrawn at any time, without any notice or penalty: e.g., money deposited into a checking account at a bank.

The rate of return of a time deposit is higher than that of a savings account, since the requirement that the deposit be held for a prespecified term gives the bank the ability to invest it in higher-gain financial products. However, the long-term return on a time deposit is generally lower than that of riskier products such as stocks or bonds. Some banks offer market-linked time deposit accounts which offer potentially higher returns while guaranteeing principal.

In its strict sense, a certificate of deposit is different from a time deposit in terms of its negotiability: a certificate of deposit is negotiable and can be rediscounted when the holder needs some liquidity, while a time deposit must be kept until maturity.

In the United States, a "small" time deposit is defined as one under $100,000, while a "large" one is $100,000 or greater in size. The term "jumbo CD" is commonly used in the United States to refer to a large time deposit. Banks in the United States are not subject to a reserve requirement against their time deposit holdings.

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