## reserverequirements

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---

### Role and definitions
- A reserve requirement (RR) requires some financial entities to hold a specified balance at the central bank.
- Three overlapping concepts:
  - RR—the amount required to be held through regulation.
  - Voluntary reserves—the amount held for precautionary reasons.
  - Excess reserves—the amount held in excess of the RR; excess reserves can be voluntary (precautionary) or involuntary (e.g., central bank quantitative easing).

### Primary objectives and tensions
- RR objectives include:
  - Microprudential: impose liquidity buffers on financial institutions.
  - Macroprudential: increase systemwide resilience against systemic risks.
  - Monetary policy implementation in different operational frameworks.
- Multiple objectives can create conflicts; using one instrument—the RR—to meet multiple objectives can give rise to tensions.

### Recent context and usage
- The IMF’s Monetary Operations and Instruments Database (MOID), last updated in 2018, shows that 116 out of 125 central banks employ some form of RR.
- The RR has a long history, dating back to the 19th century.
- In floor systems with ample reserves, the RR can become irrelevant because excess reserves are considerably higher than the minimum required to keep short-term market interest rates close to the floor.
- Liquidity regulation implemented after the global financial crisis (including Basel III elements) has superseded the RR as a microprudential instrument in many countries.

### Key guidance and analytical conclusions
- Update and streamline RR objectives and parameterization so objectives are more closely targeted and tensions reduced.
- Where microprudential goals are intended, deploy more targeted tools (for example, adopt the liquidity coverage ratio (LCR) as soon as market conditions allow) to reduce reliance on the RR.
- When the RR is used for monetary policy implementation, average it over a sufficiently long maintenance period to facilitate intertemporal smoothing of liquidity shocks and help stabilize short-term interest rates.
- The RR could be partially included in the high-quality liquid assets (HQLA) of the LCR under appropriate conditions.

### Technical assistance (TA) recommendations to minimize costs and distortions
- Aim TA at minimizing costs and distortions arising from the RR.
- Preferred design features to minimize distortions and circumvention:
  - A comprehensive set of counterparties (including non-bank financial institutions in some circumstances).
  - A large reserve base (RB).
  - A uniform ratio.
  - Reserve-only eligibility for fulfillment (no broader asset eligibility).
  - Remuneration at the opportunity cost.
- Distortions may be necessary to achieve macroprudential objectives, but they should be temporary and considered part of a broader policy package addressing underlying issues.

### Penalties and incentives
- Set the RR penalty above the lending facility rate to provide sufficient incentive to fulfill the RR.
- Avoid excessively harsh penalties that could encourage reserve hoarding.

### Box 1 — The Precautionary Demand for Reserves: definition and determinants
- The precautionary demand for reserves is "the minimum balance that banks would always try to keep, including by financing it at the central bank lending facility if one is in place."
- Factors influencing the precautionary demand include:
  - size and frequency of liquidity shocks;
  - opportunity costs of being long or short reserves (determined by the costs of borrowing from or depositing with the central bank relative to market rates and the conditions for accessing the central bank lending facility);
  - cost of the RR under-fulfillment penalty;
  - efficiency of the payments system;
  - length of the RR maintenance period;
  - specification of the reserve requirement (averaged or not);
  - availability and price of alternative HQLA;
  - counterparty risk perception;
  - efficiency of the interbank market.
- The precautionary demand is not directly observable and is conditional on exogenous variables that can change; it can only be estimated with some degree of forecast error.

### Box 1 — Four common estimation methods
- Observed minimum holdings of reserves
  - Use historic reserve holding patterns by individual banks, summing the minimum daily level of reserves held by each bank over several maintenance periods and selecting the lowest outturn as an indication of the precautionary reserves.
  - Empirical operation: sum of minimum daily holdings across banks over maintenance periods and selecting the lowest outturn as the precautionary reserve indicator.
- Estimate the conditional distribution of reserves
  - Estimate the distribution as a function of market structure and other exogenous determinants using statistical modeling techniques such as Generalized Autoregressive Conditional Heteroscedasticity.
  - The lowest percentile of the conditional distribution represents the precautionary demand for reserves.
  - Can be done on aggregate or bank-by-bank basis.
- Money market rate sensitivity to reserve level changes
  - Infer the level of precautionary demand from the reserve level at which short-term interest rates begin to spike (non-linear relation between interest rates and reserves).
  - Estimation should factor in the non-linear relation and incorporate exogenous regressors controlling for market sentiment and other influence on demand curve shape.
- Market surveys
  - Regularly survey banks on their reserve-holding strategies (example: Federal Reserve Bank of New York surveys senior financial officers at major banks about strategies and practices for managing reserve balances every six months).

### Box 1 — Role in monetary operations and calibration
- The precautionary demand matters for designing RR parameters and calibrating open market operations (OMOs):
  - In a mid-corridor system, an RR with averaging that comfortably absorbs the estimated precautionary demand helps set a stable total demand for reserves that can be incorporated in OMO calibration.
  - The RR influences the central bank's structural liquidity position: an increase in the RR ratio reduces the structural liquidity position (makes it more negative or reduces its positive position), potentially requiring larger OMO injections if starting from a liquidity deficit.
  - In a parsimonious floor system, the RR with averaging helps calibrate the supply of reserves so the market rate is pinned to the floor; the central bank must provide slightly more than the precautionary demand for reserves.
- Because the precautionary demand is conditional and uncertain, RR design (including averaging) is important to reduce interest-rate volatility and improve the predictability of monetary operations.

### Box 1 — Interaction with averaging and maintenance periods
- The RR with averaging should "envelop the precautionary demand and is not additive (as it is without the averaging provision)."
- Reserve averaging benefits:
  - reduces liquidity risk premium because averaging flattens the demand curve for reserves and lessens the impact of liquidity shocks on interest rates;
  - allows banks to offset under-fulfillment on one day with over-fulfillment on another day within the maintenance period, pulling market rates toward the policy rate if banks expect the central bank to provide required reserves by period end and that the policy rate will not change during the maintenance period.
- The proportion of the RR subject to averaging should exceed the precautionary demand for reserves so banks do not lock that portion away from flexible use.
- Maintenance-period length and timing should support averaging benefits; a longer maintenance period reinforces averaging advantages and typical practice with averaging is one calendar month or 4–6 weeks.

### Box 1 — Practical implications for central banks
- Because the precautionary demand cannot be observed directly, central banks should:
  - use one or more of the four estimation methods to inform RR sizing and averaging provisions;
  - design RR maintenance periods and averaging to "comfortably absorb" estimated precautionary demand, reducing OMO calibration uncertainty;
  - recognize forecast error in estimates of the precautionary demand when setting the RR and OMOs to avoid unwanted interest-rate volatility.

*Source: EXECUTIVE SUMMARY and Box 1, Monetary Operations and Domestic Market Development: Reserve Requirements (IMF | MCM Technical Assistance Handbook).*

### EXECUTIVE SUMMARY ______________________________________________________________________________ 6

### Executive Summary

### Role and definitions
- A reserve requirement (RR) requires some financial entities to hold a specified balance at the central bank.
- Three overlapping concepts:
  - RR—the amount required to be held through regulation.
  - Voluntary reserves—the amount held for precautionary reasons.
  - Excess reserves—the amount held in excess of the RR; excess reserves can be voluntary (precautionary) or involuntary (e.g., central bank quantitative easing).

### Primary objectives and tensions
- RR objectives include:
  - Microprudential: impose liquidity buffers on financial institutions.
  - Macroprudential: increase systemwide resilience against systemic risks.
  - Monetary policy implementation in different operational frameworks.
- Multiple objectives can create conflicts; using one instrument—the RR—to meet multiple objectives can give rise to tensions.

### Recent context and usage
- The IMF’s Monetary Operations and Instruments Database (MOID), last updated in 2018, shows that 116 out of 125 central banks employ some form of RR.
- The RR has a long history, dating back to the 19th century.
- In floor systems with ample reserves, the RR can become irrelevant because excess reserves are considerably higher than the minimum required to keep short-term market interest rates close to the floor.
- Liquidity regulation implemented after the global financial crisis (including Basel III elements) has superseded the RR as a microprudential instrument in many countries.

### Key guidance and analytical conclusions
- Update and streamline RR objectives and parameterization so objectives are more closely targeted and tensions reduced.
- Where microprudential goals are intended, deploy more targeted tools (for example, adopt the liquidity coverage ratio (LCR) as soon as market conditions allow) to reduce reliance on the RR.
- When the RR is used for monetary policy implementation, average it over a sufficiently long maintenance period to facilitate intertemporal smoothing of liquidity shocks and help stabilize short-term interest rates.
- The RR could be partially included in the high-quality liquid assets (HQLA) of the LCR under appropriate conditions.

### Technical assistance (TA) recommendations to minimize costs and distortions
- Aim TA at minimizing costs and distortions arising from the RR.
- Prefer the following design features to minimize distortions and circumvention:
  - A comprehensive set of counterparties (including non-bank financial institutions in some circumstances).
  - A large reserve base (RB).
  - A uniform ratio.
  - Reserve-only eligibility for fulfillment (no broader asset eligibility).
  - Remuneration at the opportunity cost.
- Distortions may be necessary to achieve macroprudential objectives, but they should be temporary and considered part of a broader policy package addressing underlying issues.

### Penalties and incentives
- Set the RR penalty above the lending facility rate to provide sufficient incentive to fulfill the RR.
- Avoid excessively harsh penalties that could encourage reserve hoarding.

*Source: EXECUTIVE SUMMARY, Monetary Operations and Domestic Market Development: Reserve Requirements (IMF | MCM Technical Assistance Handbook).*

### Box 1. The Precautionary Demand for Reserves

### reserverequirements - Box 1. The Precautionary Demand for Reserves

### Definition and determinants
- The precautionary demand for reserves is "the minimum balance that banks would always try to keep, including by financing it at the central bank lending facility if one is in place."
- Factors influencing the precautionary demand include:
  - size and frequency of liquidity shocks;
  - opportunity costs of being long or short reserves (determined by the costs of borrowing from or depositing with the central bank relative to market rates and the conditions for accessing the central bank lending facility);
  - cost of the RR under-fulfillment penalty;
  - efficiency of the payments system;
  - length of the RR maintenance period;
  - specification of the reserve requirement (averaged or not);
  - availability and price of alternative HQLA;
  - counterparty risk perception;
  - efficiency of the interbank market.
- The precautionary demand is not directly observable and is conditional on exogenous variables that can change; it can only be estimated with some degree of forecast error.

### Four common estimation methods
- Observed minimum holdings of reserves
  - Use historic reserve holding patterns by individual banks, summing the minimum daily level of reserves held by each bank over several maintenance periods and selecting the lowest outturn as an indication of the precautionary reserves.
  - Source presents the empirical operation as: sum of minimum daily holdings across banks over maintenance periods and selecting the lowest outturn as the precautionary reserve indicator.
- Estimate the conditional distribution of reserves
  - Estimate the distribution as a function of market structure and other exogenous determinants using statistical modeling techniques such as Generalized Autoregressive Conditional Heteroscedasticity.
  - The lowest percentile of the conditional distribution represents the precautionary demand for reserves.
  - This method is an improvement over observed minimum holdings because it is conditional on relevant exogenous variables and forward looking; can be done on aggregate or bank-by-bank basis.
- Money market rate sensitivity to reserve level changes
  - Infer the level of precautionary demand from the reserve level at which short-term interest rates begin to spike (non-linear relation between interest rates and reserves).
  - Estimation should factor in the non-linear relation and incorporate exogenous regressors controlling for market sentiment and other influence on demand curve shape.
- Market surveys
  - Regularly survey banks on their reserve-holding strategies (example cited: Federal Reserve Bank of New York surveys senior financial officers at major banks about strategies and practices for managing reserve balances every six months).

### Role in monetary operations and calibration
- The precautionary demand matters for designing RR parameters and calibrating open market operations (OMOs):
  - In a mid-corridor system, an RR with averaging that comfortably absorbs the estimated precautionary demand helps set a stable total demand for reserves that can be incorporated in OMO calibration.
  - The RR influences the central bank's structural liquidity position: an increase in the RR ratio reduces the structural liquidity position (makes it more negative or reduces its positive position), potentially requiring larger OMO injections if starting from a liquidity deficit.
  - In a parsimonious floor system, the RR with averaging helps calibrate the supply of reserves so the market rate is pinned to the floor; the central bank must provide slightly more than the precautionary demand for reserves.
- Because the precautionary demand is conditional and uncertain, RR design (including averaging) is important to reduce interest-rate volatility and improve the predictability of monetary operations.

### Interaction with averaging and maintenance periods
- The RR with averaging should "envelop the precautionary demand and is not additive (as it is without the averaging provision)."
- Reserve averaging benefits:
  - reduces liquidity risk premium because averaging flattens the demand curve for reserves and lessens the impact of liquidity shocks on interest rates;
  - allows banks to offset under-fulfillment on one day with over-fulfillment on another day within the maintenance period, pulling market rates toward the policy rate if banks expect the central bank to provide required reserves by period end and that the policy rate will not change during the maintenance period.
- The proportion of the RR subject to averaging should exceed the precautionary demand for reserves so banks do not lock that portion away from flexible use.
- Maintenance-period length and timing should support averaging benefits; a longer maintenance period reinforces averaging advantages and typical practice with averaging is one calendar month or 4–6 weeks.

### Practical implications for central banks
- Because the precautionary demand cannot be observed directly, central banks should:
  - use one or more of the four estimation methods to inform RR sizing and averaging provisions;
  - design RR maintenance periods and averaging to "comfortably absorb" estimated precautionary demand, reducing OMO calibration uncertainty;
  - recognize forecast error in estimates of the precautionary demand when setting the RR and OMOs to avoid unwanted interest-rate volatility.

*IMF | MCM Technical Assistance Handbook — Box 1. The Precautionary Demand for Reserves*

### References

### References

### Works on reserve requirements, monetary policy, and capital flows
- Central Bank of Iceland. 2016. “Capital Flows and the Central Bank's New Capital Flow Management Measure.” Central Bank of Iceland Monthly Bulletin, Box 1, November.
- Ennis, H. M., and T. Keister. 2008. “Understanding Monetary Policy Implementation.” Federal Reserve Bank of Richmond Economic Quarterly 94 (3): 235-263.
- ECB (European Central Bank). 2003. “Changes to the Eurosystem’s Operational Framework for Monetary Policy.” Monthly Bulletin, August, European Central Bank, Frankfurt.
- Federico, P., C. A. Vegh, and G. Vuletin. 2014. “Reserve Requirement Policy over the Business Cycle.” NBER Working Paper 20612,    National Bureau of Economic Research, Cambridge, MA.
- Ferrara, G., S. Langfield, Z. Lui, and T. Ota. 2019. “Systemic Illiquidity in the Interbank Network.” Quantitative Finance 19 (11): 1179-1795.
- Glocker, C., and P. Towbin. 2012. “Reserve Requirements for Price and Financial Stability: When Are They Effective?” International Journal of Central Banking 8 (1): 65-113.
- Gray, S. 2011. “Central Bank Balances and Reserve Requirements,” IMF Working Paper 11/36, International Monetary Fund, Washington, DC.
- Ostry, J. D., A. R. Ghosh, K. Habermeier, L. Laeven, M. Chamon, M. S. Qureshi, and A. Kokenyne. 2011. “Managing Capital Inflows: What Tools to Use?” IMF Staff Discussion Note 11/06, International Monetary Fund, Washington, DC.

### IMF institutional and country reports referenced
- IMF (International Monetary Fund). 2012a. “The Liberalization and Management of Capital Flows: An Institutional View.” IMF Board Paper, International Monetary Fund, Washington, DC.
- IMF (International Monetary Fund). 2012b. “The Interaction of Monetary and Macroprudential Policies— Background Paper.” IMF Policy Paper, International Monetary Fund, Washington, DC.
- IMF (International Monetary Fund). 2014a. “Staff Guidance Note on Macroprudential Policy—Detailed Guidance on Instruments.” International Monetary Fund, Washington, DC.
- IMF (International Monetary Fund). 2014b. “Staff Guidance Note on Macroprudential Policy— Consideration for Low Income Countries.” International Monetary Fund, Washington, DC.
- IMF (International Monetary Fund). 2019. “Bosnia and Herzegovina, Technical Assistance Report— Implementation of a New Reserve Requirement Framework.” IMF Country Report 19/316, International Monetary Fund, Washington, DC.
- IMF (International Monetary Fund). 2020. “Chile Technical Assistance Report—Central Bank Services to Nonbank Financial Institutions.” IMF Country Report 20/160, International Monetary Fund, Washington, DC.

*Source: reserverequirements - References (PDF).*

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_Source: https://www.imf.org/-/media/files/publications/miscellaneous/english/2022/reserverequirements.pdf_