## _wp1136

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### I. Introduction — scope and framing
- Over 90 percent of central banks oblige depository institutions (commercial banks) to hold minimum reserves against their liabilities, predominantly as central bank balances.
- The paper identifies three main stated purposes for reserve requirements (RR): Prudential; Monetary control; Liquidity management.
- Definitions and usage preserved exactly from source:
  - Central bank (or “reserve” or “base”) money = currency in issue plus commercial bank balances held at the central bank.
  - “Excess reserves” = balances in excess of required reserves.
  - “Surplus reserves” = balances above demanded levels; excess reserves are equal to or greater than surplus reserves.
- Paper structure (sections referenced): II (reasons for RR); III (reserves remuneration as a policy tool); IV (IMF survey data on 121 central banks); V (technical issues). Appendices I–VII for detailed technical discussion.
- Key descriptive findings:
  - In 2010, over 80 percent of central banks permitted at least some element of reserve averaging.
  - Remuneration of reserves reduces the distortionary tax effect and weakens or eliminates RR impact on interest rate spreads.

### II. Purposes of reserve requirements (RR)
- Prudential
  - Historically RR ensured banks held high-quality liquid assets against runs; central bank lending complemented reserves.
  - Prudential role now largely covered by supervision, regulation (capital and liquidity requirements), deposit insurance, and standing central bank credit facilities.
  - Reserve averaging weakens prudential benefits; in 2010, over 80 percent of central banks permitted at least some averaging.
  - When supervision is not a central bank function, remunerating reserve balances may not be an appropriate prudential incentive.
- Monetary control
  - RR can restrict bank balance-sheet growth if reserve money cannot be easily increased.
  - Varying unremunerated RR (URR) can influence deposit–lending rate spreads and thereby monetary aggregates and inflation.
  - Remuneration of RR reduces the interest-spread channel.
- Liquidity management
  - Active use: immobilize surplus reserves to avoid surplus-induced low interest rates or currency depreciation.
  - Passive use: reserve averaging facilitates short-term liquidity management and reduces short-term interest rate volatility.
  - Central banks need to estimate surplus reserves to judge offset actions.

### III. Key technical and policy trade-offs
- Reserve averaging vs. prudential coverage
  - Averaging is a powerful liquidity tool but undermines prudential protection since banks may draw down reserves under stress.
- Remuneration
  - Paying interest on reserves reduces distortions and incentives to avoid reservable liabilities, but diminishes RR’s impact on interest rate spreads.
  - The remuneration rate on excess reserves can be used to signal monetary policy stance (a “floor” system) — suited for central banks with structural surpluses or uncertain demand for reserves.
- Voluntary vs. demanded reserves
  - Voluntary demand for settlement balances rises if balances are remunerated and varies with short- and long-term factors.
  - Some central banks set RR above voluntarily-held levels to create predictable demand; if not too high and remunerated, distortion may be limited.
- Observability
  - Excess reserves are observable (actual balances minus required levels).
  - Surplus reserves are harder to observe because demanded levels vary over time.

### IV. Liquidity management, money-multiplier logic, and URRs
- Money multiplier and control of credit growth
  - In fiat systems, central bank can create reserves (subject to collateral), so using reserve money to limit credit is effectively an indirect use of interest rates.
  - Example mechanism preserved verbatim: if market short of 100 in reserve balances, central bank could lend 100 via OMO at market rates; or lend only 50 via OMO and force banks to fund remaining 50 via standing credit facility at higher rates.
  - For structural reserve surpluses central bank could drain surplus via OMO or drain part and remunerate remainder at the standing deposit facility rate; remunerating surplus may result in market rates falling below policy rate if surplus remains remunerated.
- Interest rate spreads and credit (URR effects)
  - URRs or RRs remunerated substantially below market rates impact the spread between deposit and lending rates.
  - URR functions like a tax: deposit rates lower and/or lending rates higher.
  - URRs are a relatively imprecise policy tool, changes are unusual more than once a year, and have implementation lags (e.g., next reserve maintenance period).
  - URRs can encourage disintermediation and evasion; effectiveness limited if inflows bypass banks.
  - Marginal URR: can be set high (example: 100 percent or more) to drain surplus balances and impose high cost on marginal loans; used as capital control (example preserved: Peru used this instrument in 2010).
- Chile example (URR on FX inflows)
  - URR was a one–year compulsory deposit on capital inflows; initially set in 1991 at 20 percent.
  - Implicit cost examples preserved: a 30 percent URR estimated to increase borrowing cost by about 26 percent for one month maturities, or 2 to 3 percentage points for one year maturities.
  - URR reduced to zero in 1998 after the Asian crisis.

### V. Reserve averaging, maintenance periods, and operational design
- Averaging of reserve balances
  - Definition: average end–of–day reserve balance over the Reserve Maintenance Period (RMP) must meet required level.
  - Benefits: supports short-term liquidity management, creates intertemporal buffer, reduces overnight rate volatility, supports interbank trading and capital market development.
  - Partial averaging: e.g., with RR = 10 percent, minimum daily level could be 5 percent allowing 50 percent averaging.
  - Around-zero systems (Canada, Mexico historically) useful with maximum positive/negative limits for end–of–day balances.
- Length and structure of RMPs
  - RMPs should be a multiple of 7 days and end midweek; a period of 4 or 5 weeks may be most effective.
  - Practical guidance: at least a 14 day RMP needed for averaging benefits; five or six working days too short.
  - Table summary preserved: (survey totals shown)
    - No RMP: 8 8.5 6.6
    - Between 1–7 days: 25 25 26.6 20.7
    - Between 8–14 days: 16 27 17.0 22.3
    - > 15 days: 41 57 43.8 47.1
    - Varies: 4 4.3 3.3
- Pattern of reserve fulfillment and operational frequency
  - Neutral allocation: cumulative average reserve balances should align with RMP target ahead of operations.
  - Central banks operating daily can be more accommodative if demand tracked (examples: RBA, Bank of Canada, Bank of Japan, US Fed).
  - Bank of Canada targets virtually zero reserves and operates daily.
- Carry–over and target bands
  - Small carry–over or target range reduces end–period rate spikes; bank may carry a 1 unit shortfall forward by overshooting in following RMP rather than pay penalty.
  - Bank of England example: target band initially +/– 1 percent when voluntary contractual reserves introduced May 2006; increased after August 2007 turmoil.
- Foreign-currency RR and transactions accounts
  - If RR on FX liabilities are paid in foreign currency and averaging allowed, central bank must provide transactions facilities for FX accounts and consider administrative/charging policy.

### VI. Technical choices for RR base, composition, and remuneration
- Reserve requirement base — inclusions/exclusions
  - Common practice: apply RR to liabilities with original maturity under 2 years, regardless of currency, excluding liabilities to other banks subject to same RR regime.
  - In some 80 percent of cases RRs apply regardless of currency of denomination (different rates may apply to foreign currency RRs).
  - Interbank deposits excluded in 90 percent of cases; less than 10 percent include interbank loans.
  - Treatment of repos varies (ECB applies zero RR to repos regardless of counterparty).
- Timing and calculation of reserve base
  - Recommended: fully lagged calculation based on daily average of reservable liabilities in calculation period, including weekends and bank holidays.
  - Most commonly (80 percent) calculation is fully lagged.
  - Alternatives: semi-contemporaneous systems (Japan, Korea examples), or month-end reporting with lagged RMP start.
- Single RR rate recommendation and differentiation practices
  - Recommended practice: use a single RR rate for all reservable liabilities unless clear and achievable goals justify differentiation.
  - Around 40 percent of central banks use multiple RR ratios depending on liability nature.
  - Differentiation can induce liability re-characterization and complicate liquidity management.
- Assets eligible to meet RR
  - Recommended: central bank balances (excluding remunerated term deposits) and possibly vault cash up to a limit; exclude securities as best practice if RR serve monetary policy.
  - Around a quarter of central banks allow vault cash to count; example limit cited up to 60 percent of RR.
  - Inclusion of securities can distort liquidity management and yield curve when central bank operations change.
- Currency of denomination choices for FX liabilities
  - In around 30 percent of cases (2010) RR on foreign-currency liabilities are payable in foreign currency.
  - IMF guidance (Kovanen (2002) cited): denominate reserve assets in local currency in stable macro environments; paying RR in domestic currency against FX liabilities can act as automatic stabilizer.
  - Changing RR denomination can have exchange-rate effects analogous to intervention.
- Remuneration prevalence and guidance (Table 3, 2010)
  - At PR: Number = 7; Percent = 5.8
  - Fixed margin below PR: Number = 3; Percent = 2.5
  - Below PR: Number = 25; Percent = 20.7
  - No Remuneration: Number = 86; Percent = 71.1
  - Total respondents = 121; Percent total = 100
  - Guidance: remunerate when goal is liquidity management/averaging; withhold full remuneration when goal is to widen deposit–lending spreads or cheaply drain liquidity.

### VII. Penalties, enforcement, and illustrative mechanics
- Penalty design for RR shortfalls
  - Penalty interest rate should normally be higher than the standing credit facility rate.
  - If excess reserves unremunerated, logical penalty to balance incentives is two times the policy rate (argument preserved from source).
  - System-wide shortfalls due to central bank error may justify waivers; shortages due to banks’ choices should incur penalties.
- Impact of unremunerated RR on spreads (Appendix I examples preserved exactly)
  - Example A:
    - ASSETS: Loans 90 @10%
    - Reserve Requirements: 10 @ 0%
    - Interest income 9
    - LIABILITIES: Deposits @ 9 %
    - Interest expense 9
    - Deposit rate (9%) = Credit rate (10%) * [1–RR ratio of 0.90] ( 0.9)
  - Example B:
    - ASSETS: Loans 75 @10%
    - Reserve Requirements: 25 @ 0%
    - Interest income 7.5
    - LIABILITIES: Deposits @ 7.5% 100
    - Interest expense 7.5
    - Deposit rate (7.5 percent) = Credit rate (10 percent) * [1–RR ratio of 0.25] (0.75)
  - Other determinants of spreads include overheads, cost of capital, and idle balances (excess reserves can blunt RR changes until drained).

### VIII. Jurisdictional notes, examples, and annexed data highlights
- Survey coverage and summary statistics
  - IMF survey data on current use of RR by 121 central banks (section IV).
  - In 2010, over 80 percent of central banks permitted at least some element of reserve averaging.
- Table excerpts preserved exactly (Reserve Requirements by Income Level, 2010)
  - No RR: High Income 25.9; Medium Income 2.8; Low Income 0.0
  - 0–5: High Income 55.6; Medium Income 34.7; Low Income 27.3
  - 6–15: High Income 14.8; Medium Income 47.2; Low Income 59.1
  - 16>=: High Income 3.7; Medium Income 15.3; Low Income 13.6
- Regional breakdown (Reserve Requirements by Region, 2010)
  - AFR: No RR 0.0; 0–5 40.0; 6–15 36.0; 16>= 24.0
  - APD: No RR 11.1; 0–5 55.6; 6–15 25.9; 16>= 7.4
  - EUR: No RR 18.2; 0–5 50.0; 6–15 27.3; 16>= 4.5
  - MCD: No RR 0.0; 0–5 32.0; 6–15 56.0; 16>= 12.0
  - WHD: No RR 9.1; 0–5 9.1; 6–15 68.2; 16>= 13.6
- Detailed Table 2 respondent counts and regime breakdown (preserved verbatim)
  - Number of respondents: 2008: 94; 2010: 121
  - No RR: 2008 = 9.6; 2010 = 7.4
  - one RR 0–5: 2008 = 25.5; 2010 = 24.0
  - one RR 6–15: 2008 = 41.5; 2010 = 23.1
  - One RR 16 >= 2008 = 8; 2010 = 5.3
  - Range RR 0–5: 2008 = 2.1; 2010 = 14.0
  - Range RR 6–15: 2008 = 10.6; 2010 = 19.0
  - Range RR 16>=: 2008 = 5; 2010 = (blank); percent column shows 2008 = 5.3; 2010 = 5.8
- ECB operational details preserved
  - €100,000 deduction per Member State establishment applied to reserve requirement.
  - Remuneration: holdings of required reserves remunerated at the average over the maintenance period of the ECB’s rate on main refinancing operations; excess holdings not remunerated.
  - Remuneration paid on the second NCB business day following the end of the maintenance period.
- United States reserve requirement levels preserved exactly (as excerpted)
  - Net transaction accounts:
    - $0 to $9.3 million 0 12–20–07
    - More than $9.3 million to $43.9 million 3 12–20–07
    - More than $43.9 million 10 12–20–07
  - Nonpersonal time deposits 0 12–27–90
  - Eurocurrency liabilities 0 12–27–90
- Appendix country RR entries preserved verbatim examples
  - Chile 6.6
  - India 5.75
  - Ecuador/ECB 2 (ECB listed as 2)
  - Argentina (0–20)
  - China (14–16)
  - United States (0–10)
  - Uruguay (9–12)
  - Uzbekistan (910–15)
  - Aggregate counts shown: 9, 29, 28, 8 (as presented in the source).

### IX. Main conclusions and policy implications (summary)
- Use of RR to support prudential requirements and monetary control is largely outdated and can often be more effectively achieved by other tools; nevertheless, in some markets and circumstances active use of RR may make sense.
- Central banks should normally manage reserves in an accommodating manner to avoid unwanted consequences of reserve surpluses or shortages.
- Reserve averaging can help markets cope with liquidity shocks and reduce short–term interest rate volatility; technical design of averaging systems matters (RMP length, carry–overs, bands, penalties).
- The remuneration rate on excess reserves can serve to signal monetary policy stance; this is an option for central banks with structural reserve surpluses or difficult-to-estimate reserve demand.

*Source: _wp1136 (IMF working paper excerpts and survey tables from the PDF content unit)._*

### References .............................................................................................................

### _wp1136 - References .............................................................................................................

### I. Introduction — scope and framing
- Over 90 percent of central banks oblige depository institutions (commercial banks) to hold minimum reserves against their liabilities, predominantly as central bank balances.
- The paper identifies three main stated purposes for reserve requirements (RR): Prudential; Monetary control; Liquidity management.
- Definitions and usage:
  - Central bank (or “reserve” or “base”) money = currency in issue plus commercial bank balances held at the central bank.
  - “Excess reserves” = balances in excess of required reserves.
  - “Surplus reserves” = balances above demanded levels; excess reserves are equal to or greater than surplus reserves.
- The paper’s structure (as described):
  - Discussion of reasons for RR (section II).
  - Review of reserves remuneration as a policy tool (section III).
  - Data on current use by 121 central banks from an IMF survey (section IV).
  - Technical issues relating to reserves (section V).
- Key descriptive findings:
  - In 2010, over 80 percent of central banks permitted at least some element of reserve averaging.
  - Remuneration of reserves reduces the distortionary tax effect and weakens or eliminates RR impact on interest rate spreads.

### II. Purposes of reserve requirements (RR)
- Three primary rationales described:
  - Prudential
    - Historically tied to gold standard and fractional banking: RR ensured banks held high-quality liquid assets to provide protection against liquidity and solvency risks.
    - RR centralized in central banks over time; central bank lending complemented reserves to mitigate runs.
    - The prudential role is now largely covered by supervision, regulation (capital and liquidity requirements), deposit insurance, and standing central bank credit facilities.
    - Reserve averaging weakens prudential benefits; in 2010, over 80 percent of central banks permitted at least some averaging.
    - If prudential goals can be met more efficiently with other tools, the prudential role of RR may be outdated.
    - When banking supervision is not a central bank function, remuneration of reserve balances may not be an appropriate incentive to satisfy prudential objectives.
  - Monetary control
    - RR can restrict commercial bank balance sheet growth if reserve money cannot be easily increased.
    - Varying unremunerated RR can be used to influence the spread between deposit and lending rates, affecting monetary aggregates and inflation.
    - Remuneration of RR reduces this interest-spread channel.
  - Liquidity management
    - Active use: central bank can immobilize surplus reserves to prevent surplus-induced low interest rates or currency depreciation.
    - Passive use: allowing RR to be met on average over a period facilitates short-term liquidity management by banks and reduces short-term interest rate volatility.
    - Central banks need to estimate surplus reserves to judge whether action is required to offset unwanted monetary impacts.

### III. Key technical and policy trade-offs
- Reserve averaging vs. prudential coverage:
  - Reserve averaging is a powerful liquidity management tool but undermines prudential protection because banks may draw down reserves under stress.
- Remuneration:
  - Paying interest on reserves reduces distortions and incentives to avoid reservable liabilities, but diminishes RR’s impact on interest rate spreads.
  - The remuneration rate on excess reserves can be used to signal monetary policy stance (a “floor” system) — relatively unusual but potentially suitable for central banks facing structural reserve surpluses or uncertain demand for reserves.
- Voluntary vs. demanded reserves:
  - There is always voluntary demand for central bank settlement balances; the volume rises if balances are remunerated and varies with short-term and longer-term factors.
  - Some central banks set RR above voluntarily-held levels to create predictable demand; if not too high and remunerated, distortion may be limited.
- Observability:
  - Excess reserves are observable (actual balances minus required levels).
  - Surplus reserves are harder to observe because demanded levels vary over time.

### IV. Main conclusions and policy implications (as stated in the paper)
- The use of RR to support prudential requirements and monetary control is largely outdated and can often be more effectively achieved by other tools; nevertheless, in some markets and circumstances active use of RR may make sense.
- Central banks should normally manage reserves in an accommodating manner to avoid unwanted consequences of reserve surpluses or shortages.
- Reserve averaging can help markets cope with liquidity shocks and reduce short–term interest rate volatility; technical design of averaging systems matters.
- The remuneration rate on excess reserves can serve to signal monetary policy stance; this is an option for central banks with structural reserve surpluses or difficult-to-estimate reserve demand.

### V. Notable data and references within the text
- Survey coverage: data on the current use of RR by 121 central banks (section IV).
- Year-specific statistic: In 2010, over 80 percent of central banks permitted at least some element of reserve averaging.
- Sections and appendices referenced (for detailed technical discussion): sections II, III, IV, V; Appendices I–VII also outlined in the content.

*Source: _wp1136 - References .............................................................................................................*

### 17. The uses of RRs for monetary control are normally described in terms of two

### _wp1136 - 17. The uses of RRs for monetary control are normally described in terms of two

### The money multiplier and control of credit growth
- The money multiplier approach assumes banks increase loan portfolios until constrained by reserve requirements, on the assumption that the supply of reserves is constrained.
- If a minimum fraction of commercial bank borrowing needs to be covered by reserves (gold), then the availability of reserves (gold) must necessarily limit bank borrowing and thereby its capacity to lend. (Credit funded by non–reservable liabilities would not be so constrained.)
- Under a currency board system (or the gold—or other specie—standard), reserve money creation is constrained by the requirement that it be backed by specified assets; central bank purchase of foreign exchange or gold provides an external backing to reserve money; the purchase of government securities may also provide backing, but is closer to secured lending.
- Once “reserves” comes to mean “balances at the central bank,” the central bank can easily accommodate any increase in the demand for reserves—provided banks hold adequate collateral—since it can create them.
- Using control over reserve money to guide credit growth in a fiat money system is in practice an indirect means of using interest rates.
  - Example mechanism: if the central bank estimates the market to be short of 100 in reserve balances, it could lend 100 via OMO at market rates; or lend only 50 via OMO and force banks to fund the remaining 50 via the standing credit facility at higher rates, raising banks’ overall cost of funding and passing this on to customers.
  - In recent years central banks have increasingly adjusted the policy rate explicitly rather than expecting the market to infer it from the balance of reserves supplied between OMO and a standing credit facility.
- Distinction: monetary policy stance vs reserve money (liquidity) management is clearer when policy rate is adjusted explicitly and reserve money supply is accommodative.
- For structural surplus of reserve balances:
  - Central bank could drain the surplus via OMO at/around targeted market rate or drain only part and remunerate remainder at the interest on excess reserves/standing deposit facility rate.
  - Result: market interest rates would be expected to fall below the policy rate if surplus remains remunerated at the standing deposit facility.

### Interest rate spreads and credit
- Unremunerated RRs (URRs), or RRs remunerated substantially below prevailing market rates, should impact the spread between commercial banks’ deposit and lending rates.
  - If a proportion of assets backing a deposit liability must be held as non–interest bearing balances at the central bank, the average interest rate charged on other assets must be correspondingly higher than the average rate paid on deposits.
  - The imposition of URRs will mean deposit rates are lower than they otherwise would have been, or lending rates higher, or both.
- An increase in URR is normally viewed as a monetary policy tightening and vice versa, but the impact differs from an increase in official interest rates:
  - Higher URRs that lead to higher lending rates clearly tighten stance.
  - Some impact passes through to deposit rates (unless at/near the zero lower bound), so lower deposit rates are not obviously a tightening.
  - RR directly affect only institutions subject to the RR regime (typically banks), producing potentially uneven effects compared with changes in official interest rates.
- Potential policy benefit: raising URR can tighten monetary conditions without encouraging short–term capital inflows (since it may increase lending rates but not deposit rates), thus avoiding attracting more inflows that could offset policy tightening.
  - The higher URR functions like a tax and, being unmatched by expenditure, should reduce net demand.
- Marginal URR usage:
  - Some central banks have used a marginal URR as a temporary measure to tackle strong credit growth or lean against capital inflows.
  - A marginal URR could be set at 100 percent or more to quickly drain surplus reserve balances and impose a high cost on marginal loans while having little direct impact on banks not expanding their balance sheets.
  - A high marginal URR on non–resident deposits in domestic currency has been used as a form of capital control (Peru used this instrument in 2010, for instance).
  - The term “URR” is sometimes used to refer to an effective tax on foreign exchange capital inflows applied to flows of foreign exchange into the domestic currency rather than to stocks of deposit liabilities.
- Limitations and risks of URRs:
  - URRs are a relatively imprecise means of implementing monetary policy; changing them more than once a year is relatively unusual and changes normally take effect with a lag (e.g., from the next reserve maintenance period).
  - Banks and other financial institutions have incentives to evade the taxation impact of URRs; URRs can encourage disintermediation and push activity to less–regulated channels, distorting markets and weakening financial stability.
  - URRs on bank deposit liabilities are less effective in discouraging capital inflows if inflows are not intermediated by banks (e.g., direct purchase of securities), in which case inflows would benefit from a generalized increase in borrowing rates.
  - Where reserve requirements are non–binding (banks hold excess reserves), incentives to avoid URRs are reduced, but then URRs may have little impact.

### Liquidity management
- Averaging of reserve balances:
  - “Averaging” requires a bank’s average end–of–day reserve balance over the reserve maintenance period (RMP) to meet the required level, allowing daily variation.
  - Averaging supports commercial banks’ short–term liquidity management and creates an intertemporal liquidity buffer to offset forecast errors in the central bank’s balance sheet.
  - Averaging reduces the impact of short–term liquidity swings on overnight market rates and supports interbank trading and capital market development.
  - Introduction of averaging tends to be neutral to positive for the volume of interbank trading.
- RR as a tool to create stable demand for reserve balances:
  - If RR are set substantially above voluntary demand, the banking system’s actual demand for reserves becomes predictable—this was a feature prior to the recent financial crisis (e.g., the Eurosystem).
  - A high RR level drains a substantial amount of collateral from the market even if the IORR equals the short–term policy OMO rate.
  - Draining liquid collateral can impact the securities market; accepting illiquid collateral for regular OMO may reduce banks’ incentive to hold well–traded securities and induce banks with less liquid assets to bid heavily for central bank funds, possibly influencing the OMO rate.
- Sterilizing surplus reserve balances:
  - Increasing URRs may appear a cheap way to sterilize surplus reserves compared with draining via OMO or paying IOER, which represent a cost to the central bank.
  - Increasing URRs tends to encourage financial disintermediation and may be evaded if RRs are set on a narrow liability base.
  - Draining surplus reserves via OMO and paying IOER have different market impacts:
    - OMO can drain reserves at term and guide market rates to the middle of a policy rate corridor.
    - IOER leaves reserve balances in transactions accounts and can only set a floor to interbank rates.
  - During market turmoil from 2007 onwards, some central banks reduced reserve requirement levels to provide additional free reserve balances; a benefit of this approach vs lending additional funds at the policy rate is that it does not require additional collateral from banks, leaving collateral in the market to support interbank activity.
- Voluntary reserves:
  - A small number of central banks do not impose RR.
  - Where there is no RR, central banks can allow very low market balances (Canada), use remuneration to motivate banks to hold reserves (Australia, New Zealand), or agree a contractual level of remunerated reserves to make demand predictable (United Kingdom).
  - The level of reserves held by the banking system is largely a function of the central bank’s decision; individual banks have choice over their reserve holdings.
  - Canada and Mexico target a zero overnight reserves balance, requiring frequent OMO to keep reserve balances on track.
  - Central bank collateral policy affects the opportunity cost of reserve holding: e.g., if Central Bank A accepts only government securities while Central Bank B accepts any performing asset, the overall cost of borrowing and market rates can differ even if both lend at the same interest rate.

### Reserves remuneration as a policy signal
- The remuneration rate of excess reserves (i.e., reserves held above RR levels) can be used to signal the stance of monetary policy; this is sometimes referred to as interest on excess reserves (IOER).
- The remuneration rate on RR is not normally seen as constituting a policy rate, as individual banks have no choice whether they hold RR.
- Remuneration of RR prevents a distortionary impact but should have no short–term policy effect.

*Source: _wp1136 - 17. The uses of RRs for monetary control are normally described in terms of two*

### 39. In a system with no RR, there is most commonly a single rate used for

### _wp1136 - 39. In a system with no RR, there is most commonly a single rate used for

### IOER, IOAR, and the floor to interbank rates
- In a system with no RR, a single rate commonly remunerates all reserve balances; this is referred to as IOER (Interest on Excess Reserves) here because all reserve balances are in excess of the zero RR rate.
- IOER is used to include situations where the rate on IOER and on required or agreed reserves are set at the same level, even if technically there are two rates.
- An IOER should set a floor to interbank rates (footnotes 15, 16).
- If there is a single rate, it will necessarily be below the overnight interbank rate because a bank with surplus reserves would have no incentive to lend to another bank at the IOER rate if it could obtain that rate with no risk and by doing nothing.
- The interbank rate does not have to be far above IOER; examples of Australia, Canada and Norway indicate that around 25bp may be sufficient to motivate trading where perceived counterparty credit and liquidity risk is low.

### Country examples and policy-rate corridors
- Norway
  - The key policy rate announced is that for remuneration of overnight deposits.
  - The overnight market rate has for long periods been in the region of 20–25 bp above this level (rather than in the middle of the corridor, currently 100bp wide), but rose to the top of the corridor in late 2008 reflecting the global financial crisis, before subsiding again.
- United States and United Kingdom (at present in the document)
  - IOER has become the key policy rate: all reserve balances are remunerated at a single rate, and there are no short–term OMO (footnote 17).
  - In the Eurosystem (mid–2010), differentiation existed between IORR and IOER (100bp and 25bp respectively), but the large volume of excess reserves made IOER the guide for short–term market rates.
  - The effective Federal funds rate (FFR) traded below the IOER ‘floor’ because the FFR calculation included GSE trades; however, the maximum bid rate—which likely represents genuine interbank trades—was fairly stable at 12.5–15bp above the IOER rate.
  - In the United Kingdom, SONIA is not a pure interbank rate; Sterling overnight LIBOR and the highest transaction rate in the SONIA data have been around 5bp above the IOER rate.
  - Not all U.K. banks have reserve accounts at the central bank, so Bank Rate does not set a floor even for interbank rates; very large transactions with a small spread may influence the average rate (example: a 5bp marginal return on GBP1 million amounts only to GBP1.37, so an overnight transaction on less than GBP10 million would scarcely cover administration costs of a marginal 5bp gain) (footnote 18).

- Other countries with no RR
  - Australia and Canada operate with a 50bp corridor.
  - Sweden has a policy rate corridor of 150bp.
  - Mexico: targeted overnight market rate is by definition the middle of a corridor (reserve balances are not remunerated and the standing credit facility is set at twice the target rate); OMO keep the overnight rate close to the target—normally within 10bp.

### Distinctions among IORR, IOAR, IOER and implications
- If a central bank with no RR distinguishes between an IOAR and IOER, it must decide what volume of reserves are remunerated at IOAR (whereas the distinction between IORR and IOER is clear).
- It can be useful to remunerate at (or very close to) the target market rate that level of reserves required by the market as a whole for transactions purposes, eliminating a substantial cost of holding these reserves and removing the incentive to over–economize on reserve holdings (footnote 19).
- The level could be agreed with banks individually (contractual basis, e.g., United Kingdom since May 2006), informally for individual banks (New Zealand), or set for the market as a whole (Australia).
- The IOAR rate—like IORR—can be set at the mid–point of the policy rate corridor, whereas IOER cannot because it represents the floor for interbank trades.
- There is no standard relationship between IORR and IOER:
  - IOER is normally lower than or the same as IORR—most obviously when IOER is represented by a standing deposit facility rate.
  - IOER may be above IORR (example given: Japan, where RR are not remunerated but excess reserve balances earn 10bp).
  - IOAR cannot be set below IOER, since banks would have no incentive to commit to holding a level of reserves remunerated below freely–held reserves (footnote 20).

### Recent survey trends (MCM IMF surveys)
- The Monetary and Capital Markets Department conducts surveys of central bank operational frameworks every two to three years; the most recent surveys cover early 2008 and early 2010.
- Figure 3 and Table 1 indicate the average level and spread of RRs, split by major sub–groups.
- Table 1. Reserve Requirements by Income Level in 2010 (In percent of Own Income Group for 2010)
  - No RR: High Income 25.9; Medium Income 2.8; Low Income 0.0
  - 0–5: High Income 55.6; Medium Income 34.7; Low Income 27.3
  - 6–15: High Income 14.8; Medium Income 47.2; Low Income 59.1
  - 16>=: High Income 3.7; Medium Income 15.3; Low Income 13.6
- Table 1. Reserve Requirements by Region (In Percent of Countries in the Region)
  - AFR: No RR 0.0; 0–5 40.0; 6–15 36.0; 16>= 24.0
  - APD: No RR 11.1; 0–5 55.6; 6–15 25.9; 16>= 7.4
  - EUR: No RR 18.2; 0–5 50.0; 6–15 27.3; 16>= 4.5
  - MCD: No RR 0.0; 0–5 32.0; 6–15 56.0; 16>= 12.0
  - WHD: No RR 9.1; 0–5 9.1; 6–15 68.2; 16>= 13.6

### Technical issues: common choices and recommended practices
- Key issues central banks face when deciding on reserve requirements (RR) include:
  - What should be included in the reserve base? Contemporaneous or lagged calculation? End–period or period–average? (section V.A)
  - Should the same rate apply to all banks, and to all types and currency denominations of eligible liabilities? (section V.B)
  - Which assets should count towards meeting a reserve requirement? Domestic currency or currency of denomination of the liability? (section V.C)
  - Should reserve requirements be remunerated? (section V.D)
  - Should reserve averaging be allowed, and if so, with what constraints and over what period? (section V.E)
  - Structure of RMPs, reserve carry–overs or bands, and penalties (sections V.F, V.G, V.H)

A. The reserve requirement base — inclusions and exclusions
- Common practice: apply RR to commercial bank liabilities with original maturity under 2 years, regardless of currency of denomination, but excluding liabilities to other banks subject to the same RR regime.
- RRs are applied to liabilities of authorized banks (depository institutions).
- In some 80 percent of cases, RRs apply to liabilities regardless of currency of denomination (though different rates may apply to foreign currency RRs).
- In most cases, liabilities with original maturity over 2 years are excluded; interbank deposits are excluded in 90 percent of cases.
- Excluding foreign currency liabilities can be seen as encouraging dollarization (use of any non–domestic currency); no central bank wants to encourage dollarization while maintaining its own currency of issue (footnote 21).
- Interbank transactions are commonly excluded to avoid double–counting and to avoid discouraging development of the interbank market; two glosses:
  - Exclusion limited to liabilities to banks subject to the same RR regime (footnote 22).
  - All liabilities to such banks should be captured, including CDs or other securities; documentation may be required (ECB example; footnote 23).
- Less than 10 percent of central banks include interbank loans in the reservable base.
- Treatment of repos varies: some central banks exclude repos (ECB applies zero RR to repos regardless of counterparty), Bank of England excludes repo transactions with other banks, U.S. reserve requirements impact only transactions accounts so repo liabilities are not included.

B. Timing and calculation of the reserve base
- Recommended practice: RR calculation fully lagged and calculated on the basis of the daily average of reservable liabilities in the relevant period, including weekends and bank holidays.
- Contemporaneous calculation may be used where RR are seen as controlling a particular monetary aggregate precisely, but creates uncertainty for banks until the end of the maintenance period (U.S. Fed used contemporaneous system February 1984 to July 1998).
- Semi–contemporaneous calculation: for a two–week maintenance period, RR calculated on liabilities in the two–week period ending at the end of the first week of the maintenance period (Japan and Korea still use semi–lagged systems).
- Most commonly (80 percent of cases) the RR calculation is fully lagged.
- Practical reporting options: banks could report reserve base for a calendar–month at month end with a 15–20 day lag; RMP could start on the second Thursday of the next month but one and run four or five weeks.
- Ideally RR base should reflect average daily liabilities in the calculation period to avoid incentive to window–dress; if a daily average is not feasible, alternatives include weekly averages or averages of end–month liabilities over preceding six months.
- Some central banks set a de minimis level for imposition of RRs: banks below a size threshold may be exempt, or RRs not payable on the first X million of eligible liabilities.
- Where RRs are imposed on foreign–currency denominated liabilities, the central bank must decide the exchange rate to use (reporting-currency choice, end–month vs period–average, and conversion where liabilities in several foreign currencies are paid in a single foreign currency).

*Source: IMF staff paper excerpt (sections IV–V, and figures/tables referenced).*

### 58. Recommended practice is to use a single RR rate for all reservable liabilities,

### _wp1136 - 58. Recommended practice is to use a single RR rate for all reservable liabilities,

### Recommended practice on a single RR rate
- Recommended practice: use a single RR rate for all reservable liabilities, except when there are clear and achievable goals in differentiating the rates.
- Rationale: single rate preferred for competitive reasons and administrative simplicity.
- Exceptions noted:
  - Some central banks operate differentiated rates; in some cases differentiation has simple objectives, in others the link to current policy goals is less clear.
  - Preferential (lower) rates have been set for certain banks (normally state–owned banks with some form of development role), implying a subsidy and reflecting the taxation aspect of unremunerated reserves.

### Differentiation by lending or sectoral subsidy
- Practice: unremunerated RR may be reduced in proportion to commercial bank lending to a particular economic sector.
- Assessment: this is a form of subsidy, complicates liquidity management, and is likely suboptimal.

### Uniformity by type of liability
- Prevalence:
  - Around 40 percent of central banks use multiple RR ratios depending on the nature of the liability.
- Typical pattern:
  - Liabilities that are more liquid—notably, sight deposits—often carry a higher reserve requirement.
- Problems with differentiation by liability type:
  - Rationale may be unclear or outdated.
  - Leads to re–characterization of liabilities (e.g., term accounts becoming effectively sight accounts if withdrawal penalties are waived).
  - Encourages behavioral responses (transfers from non–transactions to transactions accounts, or holding funds in non–transactions accounts to avoid RR while retaining access).
  - May require a rigorous verification regime to ensure effectiveness.

### Table 2: Detailed Reported Breakdown of Reserve Requirements (in percent of total)
- Number of respondents:
  - 2008: 94
  - 2010: 121
- Breakdown by RR regime (percent):
  - No RR: 2008 = 9.6; 2010 = 7.4
  - one RR 0–5: 2008 = 25.5; 2010 = 24.0
  - one RR 6–15: 2008 = 41.5; 2010 = 23.1
  - One RR 16 >= 5: 2008 = 8; 2010 = 5.3; (percent column shows 2008 = 6.6 corresponding to 2010? source table structure preserved exactly)
  - Range RR 0–5: 2008 = 2.1; 2010 = 14.0
  - Range RR 6–15: 2008 = 10.6; 2010 = 19.0
  - Range RR 16>=: 2008 = 5; 2010 = (blank); percent column shows 2008 = 5.3; 2010 = 5.8
- Source: IMF survey of central banks

### Government deposits and RR
- Practice and prevalence:
  - Government deposits should be liable to RR; this is the case in nearly 80 percent of cases.
  - In some countries where there is no formal RR on government deposits, law specifies all government balances must be held at the central bank.
- Observed practices:
  - In a few countries, government deposits in commercial banks are subject to a higher than normal RR (occasionally up to 100 percent).
- Implications and assessment:
  - Government deposits in commercial banks likely earn a lower return than government’s cost of funding or the central bank’s cost of draining surplus reserve balances.
  - Large government balances in commercial banks may reflect inefficient cash management or favoring specific commercial banks.
  - Centralizing government funds is efficient for the state sector (government plus central bank).
  - High RR on government balances is used to discourage or offset government/quasi–government bodies holding large commercial bank balances and simulates some benefits of a Single Treasury Account.
  - For maximum impact, very high RR on government balances requires that RR balances are less than fully remunerated.

### Uniformity by currency
- Practice:
  - Most central banks impose RR on foreign–currency denominated liabilities as well as on domestic currency liabilities, and use the same rate for both.
  - In a few cases, higher RR on foreign currency liabilities is used to discourage dollarization or to discourage capital inflows; it functions as a marginal tax on the use of foreign currency.
  - Some countries apply lower RR on foreign currency liabilities to make it easier to attract foreign currency deposits (support capital account or export credits).
- Complication:
  - Handling of foreign exchange swaps may complicate measurement of RR if domestic and foreign rates differ.

### How should reserve requirements be held? (assets eligible)
- Recommended practice:
  - Include reserve balances at the central bank (excluding remunerated term deposits), and possibly vault cash up to a certain limit; do not include holdings of securities.
  - In some cases reserve balances held against foreign currency liabilities may be held in foreign currency.
- Practices and considerations:
  - Some central banks allow only central bank account balances to count; small banks may be allowed to hold reserves at a larger commercial bank which in turn holds a central bank balance on their behalf.
  - Around a quarter of central banks allow vault cash to count towards RR.
    - Example limit: up to 60 percent of the RR can be met with vault cash, with additional holdings excluded.
  - Arguments for including vault cash:
    - Vault cash is a direct central bank liability like central bank balances.
    - Inclusion supports rural banking where branches hold proportionally more cash.
  - Measurement and verification issues with vault cash:
    - Central bank knows commercial bank balances daily; many commercial banks may not know precise daily vault cash, especially with large branch networks.
    - Solutions: include vault cash with a lag (e.g., last month’s holdings count this month).
    - ATMs: cash withdrawn over weekends/public holidays can cause Friday close-of-business figures to overstate average weekend cash; excluding ATM cash is a possible but imperfect solution.
    - Concerns over independent verification: audits and periodic supervisory inspections recommended to ensure accuracy.
  - Foreign currency vault cash:
    - Less commonly allowed to count towards RR because it is not a liability of the central bank.
    - Inclusion may induce higher-than-efficient holdings of foreign currency cash, especially if RR are not remunerated.
    - Banks may prefer foreign currency vault cash to avoid interest loss and to ensure availability in crisis.
  - Inclusion of central bank or treasury bills:
    - A small number of central banks allow such securities to count towards RR.
    - If RR are purely prudential/liquidity-based, inclusion can make sense because securities can be quickly liquidated.
    - If RR serve monetary policy, drain surplus liquidity, or facilitate system liquidity management, best practice is to exclude securities because inclusion can complicate liquidity management and distort the yield curve.
      - Example distortion: banking system holding excess reserves substitutes one reserve asset for another when central bank sells bills, leaving excess reserves unchanged while pulling down the yield curve; if government-issued bills are bought and government spends proceeds, excess reserves increase, again giving banks an incentive to bid higher than non–banks and distorting the yield curve.

### Currency of denomination for RR on foreign-currency liabilities
- Practice:
  - In around 30 percent of cases (in 2010), RR on foreign currency liabilities are payable in foreign currency.
  - In some cases the foreign exchange balance can be held in an account abroad.
- IMF paper guidance (Kovanen (2002) cited):
  - Quote: “A stable macroeconomic environment and limited currency substitution call for denominating reserve assets, regardless of the corresponding liabilities, in the local currency; this would also facilitate the administration of the reserve balances at the central bank and simplify the central bank’s liquidity management....However, exchange rate instability complicates monetary management and makes it difficult for the banks to manage their liquidity when local currency liquidity changes, reflecting the revaluation of banks’ foreign currency reserve liabilities.”
- Implications and assessments:
  - Neutral position: denominate all RR in domestic currency, regardless of the currency of the underlying liability, other things equal.
  - Paying RR in domestic currency against foreign-currency liabilities can act as an automatic stabilizer:
    - Currency depreciation increases domestic-currency equivalent RR in the next maintenance period, reducing domestic currency availability and offsetting depreciation pressures via required sale of FX or higher domestic interest rates.
    - Banks face potential losses if they attracted FX from customers betting on depreciation, creating incentives to discourage currency speculation.
  - Paying RR in domestic currency affects commercial banks’ open FX positions and must be managed in overall balance sheet strategy, especially if RR ratios are high.
  - Denominating RR in foreign currency does not remove currency risk unless RR are accepted in a range of currencies; accepting many currencies would be administratively cumbersome.
  - If RR are paid in foreign currency into a central bank’s account at a foreign bank, gross and net foreign assets increase; net foreign exchange holdings of the central bank do not change because the liability to the depositing bank matches the foreign currency asset received. IMF recommends central bank accounts indicate the foreign currency liability to the domestic bank for transparency.
  - Changing the currency of denomination of RRs can have exchange rate effects analogous to intervention:
    - Requiring RR to be paid in foreign currency where they arise on foreign exchange liabilities returns domestic currency to the banking system and requires banks to give up foreign exchange, putting downward pressure on the exchange rate; the reverse switch has the opposite effect.

### Remuneration of reserve requirements
- Assessment:
  - Unremunerated RR, especially if high, are distortionary.
  - If eliminations of distortion are desired, RR remuneration should ideally be at or close to the targeted policy rate.
- Prevalence (Table 3. Remuneration Rates, 2010):
  - At PR: Number = 7; Percent = 5.8
  - Fixed margin below PR: Number = 3; Percent = 2.5
  - Below PR: Number = 25; Percent = 20.7
  - No Remuneration: Number = 86; Percent = 71.1
  - Total respondents = 121; Percent total = 100
- Guidance:
  - Whether to remunerate, and at what level, depends on RR purposes:
    - If goal is to widen spread between deposit and lending rates, or to drain liquidity “cheaply,” RR should not be fully remunerated.
    - If the goal is to immobilize surplus reserves at low cost to the central bank, full remuneration defeats the purpose.
    - If the purpose is to support liquidity management through averaging, remuneration is preferable because unremunerated RR act as a distortionary tax on financial intermediation via banks.

*Italic: Source: _wp1136 - 58. Recommended practice is to use a single RR rate for all reservable liabilities,*

### 85. If RR are remunerated, the “neutral” rate at which to remunerate is the

### _wp1136 - 85. If RR are remunerated, the “neutral” rate at which to remunerate is the

### Remuneration: opportunity cost as the “neutral” rate
- The neutral rate at which to remunerate reserves (RR) is the opportunity cost.
- Structural shortage of liquidity: the obvious rate to choose is the main lending rate; if the operational framework is effective, this should approximate to short–term interbank rates.
- Structural surplus of liquidity: if the central bank is draining some of the excess liquidity at or around a target short–term rate, the opportunity cost should equate to that rate.
- Remuneration need not be exactly at the opportunity cost:
  - Example: it could be somewhat lower, e.g., 25 bp below the target policy rate.
  - If constrained by the overall cost of its operations, the central bank could set remuneration at a wider spread below its policy target. A fixed spread below the policy rate should mean the distortion implied by the partial tax on intermediation does not vary when the policy rate varies.
- Foreign–currency RR:
  - If RR imposed on foreign–currency liabilities are held in foreign currency, the central bank could remunerate them at a different rate to domestic currency RR.
  - If the opportunity cost is seen as the international interbank rate for the relevant currency, RR held in foreign currency could be remunerated at a spread below this.
  - If RR on foreign–currency liabilities are held in domestic currency and remunerated at domestic market rates, short–term capital inflows might be encouraged if domestic interest rates are relatively high; this would have the same impact as if surplus reserves are drained at market rates via domestic currency OMO.
- Historical note: the US Fed operated Contractual Clearing Balances during RMPs with a band (+/– USD 25,000 or 2 percent of the target) and credits calculated as 80 percent of the moving average of 3 month Treasury bill yields; by law the Fed could not pay interest on these balances, but since October 2008 the Fed has been able to remunerate reserve balances.
  - Comment in source: “From a fiscal perspective, zero remuneration is almost certainly not optimal: zero remuneration implies a tax that varies with the nominal interest rate, which is at best imperfectly controlled and cannot readily be set at the level that is optimal from an efficiency point of view.” [Hardy, 1993].

### Averaging of Reserve Requirements (Section E)
- Averaging enhances liquidity management by commercial banks and reduces strain on central bank liquidity–management operations.
- Reserve maintenance periods (RMPs) need to be at least two weeks long.
- Definition: Averaging means the requirement is assessed against the average end–of–day balances maintained over a specified period in a transactions account at the central bank.
- Key benefits:
  - Reduces/largely eliminates volatility in short–term interest rates caused by supply/demand imbalances for liquidity.
  - Banks have automatic recourse to their balances on a daily basis so long as the average level during the maintenance period equals or exceeds the RR target.
  - If swings in liquidity on a given day cannot be accommodated in the market at the expected rate, a bank can allow its reserve balance to take the strain, tending to pull market rates towards the targeted policy rate (provided the market expects the central bank to inject/drain the requisite volume of liquidity, at the policy rate, over the RMP as a whole).
- Partial averaging:
  - Used when RR level is relatively high and averaging is first introduced.
  - Example: If RR are 10 percent, the central bank could set a minimum daily level of 5 percent, allowing 50 percent averaging.
  - If RR level is 2 percent (as in the Eurosystem), partial averaging would make less sense.
  - Important: scope for liquidity management provided by averaging should be large relative to likely daily liquidity shocks.
- Around-zero systems: when practiced (Canada and Mexico in past), it can be useful to set maximum positive and negative values for end–of–day balances.

### Length and structure of the Reserve Maintenance Period (Section F)
- When averaging is permitted:
  - RMPs should be a multiple of 7 days, and should end mid–week.
  - A period of 4 or 5 weeks may be the most effective and is used by many central banks.
  - A longer period would likely weaken prudential or monetary control function of RR without providing significant benefit to liquidity management.
- Table summary (from IMF survey of central banks):
  - No RMP: 8 8.5 6.6
  - Between 1–7 days: 25 25 26.6 20.7
  - Between 8–14 days: 16 27 17.0 22.3
  - > 15 days: 41 57 43.8 47.1
  - Varies: 4 4.3 3.3
  - (Totals shown as 94 121 100 100 in table formatting)
- Practical guidance:
  - At least a 14 day RMP is needed for banks to benefit from averaging; one week is not long enough.
  - Five or six working days are too short for inter–temporal substitution and forecasting.
  - A 4 to 5 week period may be optimal; periods longer than one month are exceptional.
  - Many transactions have a monthly cycle (salary, pension, tax flows) making monthly forecasting easier.
  - Concerns about one–month RMP (speculation, excessive swings) can be managed by partial–averaging and determining the pattern of reserve fulfillment.
- Eurosystem and Bank of England practice:
  - Set RMPs to run between monetary policy decision meeting dates and use 7 day maturity for OMO conducted at the policy rate, avoiding overlap between policy–rate operations and policy decisions or RMPs.
- Weekends and public holidays should be counted in reserve averaging; excluding them may cause distortions (banks less willing to borrow over a weekend if only one day counts towards RR).
- Best practice: RMPs should end midweek (e.g., Wednesday) because:
  - Liquidity forecasting is easier midweek than the day before/after a weekend.
  - Ending midweek helps avoid end–period spikes in short–term rates and stabilizes rates during preceding days.
- If averaging is not permitted: RMP length can be administrative; a one calendar month period may strike the best balance. A 6 or 12 month period would weaken monetary policy function.
- Footnotes/examples:
  - If the period is set to end on the first Wednesday of each month, the RMP will vary between four and five weeks throughout the year.
  - Argentina introduced a 3 month averaging period to cover the year end when liquidity management is more difficult.

### Pattern of reserve fulfillment
- Pattern usually determined by central bank as net supplier/drainer of liquidity; can be influenced by banks’ participation in central bank liquidity operations.
- Many central banks aim to supply/drain reserves evenly throughout the RMP (ECB and Bank of England operate 4–5 week RMPs and conduct weekly liquidity auctions).
- Neutral allocation: at close of business the day before the next operation, the cumulative average reserves balances of the system as a whole should be in line with the target balance for the whole RMP.
- Observed profiles:
  - United Kingdom data: day–to–day balances show sharp but regular swings; cumulative reserves balance within each period is reasonably close to the RMP target at the end of each week. Aim is to enable banks in aggregate to accumulate reserves evenly week to week.
  - Eurosystem: displayed a neutral profile until August 2007; after market turmoil, the Eurosystem oversupplied in the first two weeks of the RMP and offset towards the end to give markets more confidence about liquidity availability.
- Central bank discretion:
  - Possible to supply/drain more than a neutral amount provided bids/demand exceed planned volume.
  - It is always possible to supply/drain less than market demand (with consequences for short–term yields).

### Operational frequency and examples
- Central banks operating daily (or most days) can respond each day to market demand and be more accommodative to short–term changes, if actual demand can be monitored.
- Examples of central banks tracking events that influence short–term demand: Reserve Bank of Australia (RBA), Bank of Canada, Bank of Japan, United States Fed.
- Bank of Canada targets virtually zero reserves and needs to operate daily to keep banks on target.
- Australia: banks effectively hold voluntary reserves (Exchange Settlement Accounts balances), remunerated at the standing deposit facility rate (25bp below the policy rate). No RMP; RBA aims to keep balances at observed smoothing level.
  - Prior to August 2007 the level was around A$750–800 million for several years; from the outset of global market turbulence the volume and variability of demand changed substantially.

### Foreign–currency RR and transactions accounts
- Where RR are held in domestic currency and averaging is practiced, RR will be held in a transactions account rather than frozen.
- If RR on foreign currency liabilities are paid in foreign currency and averaging is permitted, central banks must consider what transactions facilities to offer for foreign–currency accounts.
  - Requirements depend on administrative capabilities and charging policy.
  - Central bank would need to enable transfers to/from correspondent accounts abroad for meaningful averaging.
  - If central bank banking department can handle cross–border transactions and pass on costs, it could handle reasonable volumes, but may want to set charges to incentivize use of normal commercial channels where possible.

### Carry–over and target bands (Section G)
- A small carry–over or use of a target range can reduce interest rate spikes at the end of an RMP.
- Central bank forecasting cannot be completely accurate; the banking system as a whole will finish an RMP with either a surplus or deficit.
- Carry–over facility: a surplus or deficit within predefined limits can be carried over to the following maintenance period.
  - Example: if a bank has an average target of 100 and holds on average only 99, it could agree to target an average of 101 in the following RMP rather than paying a penalty.
- Bank of England introduced a target band for the RMP:
  - Initially band was +/– 1 percent when voluntary contractual reserves were introduced in May 2006; band was increased following market turmoil from August 2007.
  - Even +/–1 percent may provide more flexibility than banks need: in a four–week (28 day) RMP, +/–1 percent on average equates to nearly 30 percent of the target for the final day because weekly corrections and a final day fine–tuning operation allow correction for prior errors.

*Source: Excerpt from IMF working paper content (reserve requirements, averaging, RMP design and related operational practices).*

### 109. If a commercial bank fails to meet its RR, it is normal to charge a penalty

### _wp1136 - 109. If a commercial bank fails to meet its RR, it is normal to charge a penalty

### Penalties for reserve requirement (RR) shortfalls — rationale and practice
- Penalty interest rate should normally be higher than the standing credit facility rate.
- Rationale:
  - A shortfall is not collateralized, whereas borrowing from the central bank to meet RR would require collateral.
  - Central bank wants to encourage banks to use its formal operational framework and meet the RR target rather than simply holding a shortfall.
  - If excess reserves are not remunerated, the logical penalty rate to create a balanced incentive (neither excess nor deficit) is two times the policy rate.
    - Argument: excess reserves are unremunerated, so the opportunity cost of holding an excess is roughly equal to the policy rate. If a bank has a shortfall, it could have earned around the policy rate on the funds employed elsewhere (or saved that rate by not funding itself), and so should pay twice the policy rate so that the net cost of a shortage is equal to the policy rate.
- Empirical note: A number of central banks set rates on this basis.

### System-wide shortfalls and waivers
- If the banking system as a whole fails to hold sufficient reserve balances because of a central bank error (e.g., inaccurate liquidity forecast), it is unreasonable to penalize the banking system; in this case, penalties may be waived.
- If the system is short because it failed to take advantage of opportunities to borrow from the central bank (e.g., via OMO) or because it bought foreign exchange from the central bank, then applying the penalty should provide appropriate incentives to the system.

### Impact of unremunerated RR on interest rate spreads (Appendix I)
- Basic theoretical relation:
  - If RR were the only factor, the ratio between credit and deposit rates would equal the inverse of (1– reserve requirement ratio).
  - As the RR ratio increases, so does the spread between credit and deposit rates.
- Illustrative balance-sheet examples preserved exactly from source:
  - Example A:
    - ASSETS: Loans 90 @10%
    - Reserve Requirements: 10 @ 0%
    - Interest income 9
    - LIABILITIES: Deposits @ 9 %
    - Interest expense 9
    - Deposit rate (9%) = Credit rate (10%) * [1–RR ratio of 0.90] ( 0.9)
  - Example B:
    - ASSETS: Loans 75 @10%
    - Reserve Requirements: 25 @ 0%
    - Interest income 7.5
    - LIABILITIES: Deposits @ 7.5% 100
    - Interest expense 7.5
    - Deposit rate (7.5 percent) = Credit rate (10 percent) * [1–RR ratio of 0.25] (0.75)
- Other determinants of spreads:
  - Banks target profit and need to cover overheads and cost of capital.
  - Extent of idle balances (excess reserves) matters: if RR is 10 percent but banks hold unremunerated central bank assets equivalent to 15 percent to 20 percent of liabilities, small changes in RR (e.g., to 8 percent or 12 percent) might have no impact on the spread because excess reserves absorb the change.
  - In markets with substantial excess liquidity, central banks should not expect significant interest rate responses to RR changes until excess liquidity is substantially drained; at that point market rates could react very sharply.

### Liquidity function and limits of RR (Appendix II)
- Liquidity defined as the ease fractional reserve banks can meet depositor withdrawals; requires banks to maintain adequate cash or ability to acquire cash.
- Critique: requiring banks to maintain a stated level of reserves may deprive those reserves of liquidity because required reserves are not available for payment to customers.
- Liquidity of required reserves depends on:
  - length of the accounting period,
  - penalty for failing to meet the requirement,
  - level of the requirement,
  - assets used to satisfy the requirement,
  - the base upon which the requirement is calculated.

### ECB reserve base, ratios, calculation, maintenance, and remuneration (Appendix III, Box 1)
- Reserve base and reporting:
  - Balance sheet data reported to national central banks; end-of-month data used to determine the reserve base for the maintenance period starting two months later (e.g., end of February used for maintenance period beginning in April).
  - Smaller institutions may report end-of-quarter data used, with a two-month lag, for three consecutive reserve maintenance periods (e.g., end of March used for maintenance periods beginning in June, July and August).
  - Council Regulation (EC) No 2531/98 allows inclusion of liabilities from acceptance of funds and off–balance–sheet items in the reserve base; in practice, Eurosystem includes only liability categories “deposits” and “debt securities issued” in the reserve base.
  - Liabilities vis–à–vis other institutions included in the Eurosystem’s minimum reserve system and liabilities vis–à–vis the ECB and national central banks are not included in the reserve base.
  - For “debt securities issued,” issuer may deduct actual amount held by other institutions subject to the system; absent proof, a standardized deduction of a fixed percentage may be applied.
- Reserve ratios and categories:
  - Reserve ratios determined by the ECB subject to maximum limits in Council Regulation (EC) No 2531/98.
  - ECB applies a uniform non–zero reserve ratio to most items included in the reserve base (as specified in Regulation ECB/2003/9).
  - ECB sets a zero reserve ratio on:
    - “deposits with an agreed maturity of over two years,”
    - “deposits redeemable at notice of over two years,”
    - “repos,” and
    - “debt securities with an agreed maturity of over two years.”
  - ECB may change reserve ratios at any time, announcing changes in advance of the first maintenance period for which change is effective.
- Calculation of reserve requirement:
  - Reserve requirement of each institution calculated by applying reserve ratios to eligible liabilities.
  - Each institution deducts an allowance of €100,000 from its reserve requirement in each Member State in which it has an establishment.
  - Reserve requirement for each maintenance period is rounded to the nearest Euro.
- Maintenance periods:
  - ECB publishes a calendar of reserve maintenance periods at least three months before the start of each year.
  - Maintenance period begins on the settlement day of the first main refinancing operation following the Governing Council meeting at which the monthly assessment is pre–scheduled.
- Reserve holdings and accounts:
  - Institutions must hold minimum reserves on one or more reserve accounts with the national central bank in the Member State of establishment.
  - Head office responsible for fulfilling aggregate minimum reserves of all domestic establishments.
  - Institutions with establishments in more than one Member State required to hold minimum reserves with the national central bank of each Member State in which it has an establishment, in relation to its reserve base in that Member State.
  - Institutions may apply to hold minimum reserves indirectly through an intermediary (subject to conditions and Regulation ECB/2003/9).
- Remuneration:
  - Holdings of required reserves are remunerated at the average, over the maintenance period, of the ECB’s rate (weighted according to the number of calendar days) on the main refinancing operations, calculated using the formula specified in Box 1.
  - Reserve holdings exceeding the required reserves are not remunerated.
  - Remuneration is paid on the second NCB business day following the end of the maintenance period over which the remuneration was earned.
- Box 1: Liabilities treatment (preserved categories exactly as in source)
  - A. Liabilities included in the reserve base and to which the positive reserve ratio is applied
    - Deposits
      - Overnight deposits
      - Deposits with an agreed maturity of up to two years
      - Deposits redeemable at notice up of to two years
    - Debt securities issued
      - Debt securities with an agreed maturity of up to two years
  - B. Liabilities included in the reserve base and to which a zero reserve ratio is applied
    - Deposits
      - Deposits with an agreed maturity of over two years
      - Deposits redeemable at notice of over two years
      - Repos
    - Debt securities issued
      - Debt securities with an agreed maturity of over two years
  - C. Liabilities excluded from the reserve base
    - Liabilities vis–à–vis other institutions subject to the Eurosystem’s minimum reserve system
    - Liabilities vis–à–vis the ECB and the national central banks

### Additional jurisdictional examples and numerical details
- ECB allowance: €100,000 deduction from reserve requirement per Member State establishment.
- Remuneration timing: paid on the second NCB business day following the end of the maintenance period.
- United States reserve requirements (current levels excerpted exactly):
  - Net transaction accounts:
    - $0 to $9.3 million 0 12–20–07
    - More than $9.3 million to $43.9 million 3 12–20–07
    - More than $43.9 million 10 12–20–07
  - Nonpersonal time deposits 0 12–27–90
  - Eurocurrency liabilities 0 12–27–90
  - Note: Total transaction accounts consists of demand deposits, automatic transfer service (ATS) accounts, NOW accounts, share draft accounts, telephone or preauthorized transfer accounts, ineligible bankers acceptances, and obligations issued by affiliates maturing in seven days or less. Net transaction accounts are total transaction accounts less amounts due from other depository institutions and less cash items in the process of collection.
- Chile: use of unremunerated reserve requirement (URR) on foreign exchange inflows (summary preserved exactly)
  - URR was a one–year compulsory deposit of a fraction of capital inflows at the central bank; expected to reduce capital inflows by increasing cost of foreign short–term capital.
  - Initially set in 1991 at 20 percent; importers of capital could either make the deposit at the central bank or pay an upfront fee equivalent to the interest cost of the URR.
  - Implicit cost varies with maturity: example given that the 30 percent URR has been estimated to increase the cost of borrowing by about 26 percent for one month maturities, or 2 to 3 percentage points for one year maturities.
  - Le Fort and Budnevich (1996) note that expectations of an appreciating exchange rate and high returns rapidly compensated URR costs on portfolio inflows—the financial cost of the LJRR of l–3 percentage points per annum was easily offset by an expected appreciation of the exchange rate.
  - URR was reduced to zero in 1998 in response to more adverse conditions in world financial markets in the aftermath of the Asian crisis.

*Italic source attribution: Excerpts from the IMF working paper content unit _wp1136 PDF.*

### 126. The main findings and policy implications can be summarized as follows:

### _wp1136 - 126. The main findings and policy implications can be summarized as follows

### Main findings on methodological and behavioral responses
- There are important methodological problems in measuring net inflows and short–term capital inflows into Chile in many of the studies reviewed which may undermine some of their results on the impact of the URR on capital flows.
- Looking at the evolution of the various components of capital inflows, it seems that the impact of the URR in reducing specific inflows had only a short–term impact before a shift of transactions on the capital account to untaxed inflows occurred.
- Avoidance by migration via the disintermediation of the taxed domestic banking system may have also been important in reducing the effectiveness of the URR.
- One policy implication of capital controls in Chile may be that controls on capital flows are unstable, i.e., they have to evolve over time to counter the dynamic response of optimizing agents.

### Empirical conclusions from the studies reviewed
- There is some evidence that the URR has been successful in increasing domestic interest rates.
- There is relatively weaker evidence that the URR has reduced the magnitude of capital inflows into Chile and altered the composition of capital inflows in favor of medium– and long–term capital inflows.
- There is actually no evidence that the URR affected the level of the real exchange rate.

### Econometric and attribution issues
- The empirical studies reviewed contain econometric problems that may bias their conclusions either in favor or against the hypothesis of effectiveness of controls on capital inflows in Chile.
- Studies on the effectiveness of the URR in increasing domestic interest rates should control for the impact of the sterilization operations of the monetary authority on domestic real interest rates as part of the increase in interest rates during the life of the URR may have been due to them.

### Appendix material (reserve requirement levels, by country, 2010) — selected points preserved verbatim from source
- Entries include country reserve requirement indicators presented in ranges and point values, for example:
  - Chile 6.6
  - India 5.75
  - Ecuador/ECB 2 (ECB listed as 2)
  - Argentina (0–20)
  - China (14–16)
  - United States (0–10)
  - Uruguay (9–12)
  - Uzbekistan (910–15)
- Aggregate counts shown in the appendix: 9, 29, 28, 8 (as presented in the source).
- Range groupings presented:
  - Range of RR 0–5
  - Range of RR 5–15
  - Range of RR >15
- The appendix source attribution: IMF survey of central banks.

*Source: _wp1136 - 126. The main findings and policy implications can be summarized as follows.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2011/_wp1136.pdf_