Fatih Özatay, PhD - [Archive]

Story of the interest on required reserves 27/09/2010 - Viewed 1352 times

The most striking one of the decisions the CBRT (Central Bank of the Republic of Turkey) announced the last Thursday was the abolition of the interest on required reserves in lira terms. Let me put a small note for those who are distant to the issue:

Banks have to keep a certain ratio of the deposits they collect at the CBRT. The ratio is decided by the CBRT. An increase in the ratio implies that banks will be able to 'sell' a smaller proportion of the deposits they have collected by paying a certain rate of interest. This practice is not unique for Turkey, it is applied in many countries as it is seen a requirement for the soundness of the financial sector.

Some countries pay an interest for the required reserves while some others do not. Turkey was among the latter before the 2001 crisis. As known, the top priority of the program implemented following the 2001 crisis was to ensure the survival of the banking sector and maintain its ability to extend loans.

Sweden also underwent a several banking sector crisis in 1992 and secured the recovery of the sector upon successful decisions and measures. As you might remember, during the recent global crisis, the US discussed widely the reforms Sweden had implemented in the banking sector. The 'Swiss model' was presented as a good practice to the US.

In the period following the 2001 crisis, I was authorized to lead, when the President of the CBRT was absent, the meetings between the CBRT and the IMF on the practices about the banking sector that were involved in the scope of the CBRT's authorities. And the IMF delegation had Swiss experts which lived the Swiss experience and took responsibility in the design of the mentioned reforms. One of the significant matters of debate in those meetings was whether interest should be paid for required reserves. The discussion was built around two opposing factors: First, the excess liquidity that was injected to the system as a result of the bank bailout operations was a matter of concern for the CBRT. And an imposition of interest for required reserves would further the liquidity. On the other hand, banks had to regain the means to extend loans as soon as possible. And their financial structure had to be strengthened for this. The latter outweighed the former; payment an interest for the deposits kept at the CBRT as required reserves was decided and this decision was put into practice as of August 2001.

Therefore, the recent decision of the CBRT must be analyzed in several aspects. First is that with this decision the CBRT once again announces in a way that the banking sector is sound. Another aspect lies in the announcement of the decision. It refers to a former announcement:    
"...if credit conditions improve, the required reserve ratios might be used more actively as a policy tool to mitigate the macroeconomic and financial risks."  Then, the CBRT believes that the rapid expansion in credits witnessed as of the late 2009 might pose risks from this point on.

The third aspect to account when evaluating the decision is as follows: It could have been sufficient to lower the required reserve ratio to a level close to the pre-crisis levels in order to limit the credit expansion at a reasonable rate. So, it might not be convincing to associate the abolishment of interests on required reserves to this factor. Then, we have to look back and see the practices in the world. As I also said before, some countries pay interest on required reserves while some others do not.

This commentary was published in Radikal daily on 27.09.2010