Policy Instruments To Lean Against The Wind In Latin America1
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund
  • | 2 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

This paper reviews policy tools that have been used and/or are available for policy makers in the region to lean against the wind and review relevant country experiences using them. The instruments examined include: (i) capital requirements, dynamic provisioning, and leverage ratios; (ii) liquidity requirements; (iii) debt-to-income ratios; (iv) loan-to-value ratios; (v) reserve requirements on bank liabilities (deposits and nondeposits); (vi) instruments to manage and limit systemic foreign exchange risk; and, finally, (vii) reserve requirements or taxes on capital inflows. Although the instruments analyzed are mainly microprudential in nature, appropriately calibrated over the financial cycle they may serve for macroprudential purposes.


This paper reviews policy tools that have been used and/or are available for policy makers in the region to lean against the wind and review relevant country experiences using them. The instruments examined include: (i) capital requirements, dynamic provisioning, and leverage ratios; (ii) liquidity requirements; (iii) debt-to-income ratios; (iv) loan-to-value ratios; (v) reserve requirements on bank liabilities (deposits and nondeposits); (vi) instruments to manage and limit systemic foreign exchange risk; and, finally, (vii) reserve requirements or taxes on capital inflows. Although the instruments analyzed are mainly microprudential in nature, appropriately calibrated over the financial cycle they may serve for macroprudential purposes.

VI. Reserve Requirements on Bank Liabilities as a Macroprudential Tool

A. Introduction

Emerging markets have used reserve requirements (RRs) on bank deposits and other bank liabilities as a macroprudential policy tool. Although similar in spirit to the original conception of RRs as a liquidity and credit policy tool, their use with this rationale is new. This contrasts with the long-held view that considered RRs (on deposits) a supplemental monetary policy tool for macroeconomic purposes (Goodfriend and Hargraves, 1983 or Feinman, 1993) or an integral component of a financially repressed economy (McKinnon, 1973). In that light, several countries dismantled RRs with the implementation of inflation-targeting frameworks, once short-term interest rates became the main monetary policy instrument. Nonetheless, RRs have remained part of central banks’ policy toolkit.

RRs are a regulatory tool that requires banking institutions to hold a fraction of their deposits/liabilities as liquid reserves. These are normally held at the central bank in the form of cash, or other forms, such as of government securities. When applied to deposits, the regulation usually specifies the size of the requirement according to deposit type (e.g., demand or time deposit) and its currency denomination (domestic or foreign currency). The regulation also sets the holding period relative to the reserve statement period for which the RR is computed, and whether they are remunerated or unremunerated. When they apply to new deposits only they are referred to as marginal RRs. In addition, RRs can apply to domestic or foreign (non-deposit) liabilities of bank’s balance sheets (Figure 1). Finally, RRs could be applied on assets rather than liabilities (Palley, 2004).

Figure 1.
Figure 1.

Reserve Requirements on Banks Liabilities

Citation: IMF Working Papers 2011, 159; 10.5089/9781455297726.001.A006

The active management of banks’ RRs can serve different macroprudential purposes.2

  • First, they can serve a countercyclical role for managing the credit cycle. In the upswing, hikes in RRs may increase lending rates, slowdown credit, and limit excess leverage of borrowers in the economy, thus acting as a speed limit (see discussion below). In the downswing, they can ease liquidity constraints in the financial system, thus operating as a liquidity buffer. In this regard, RRs can serve as a flexible substitute for other macroprudential tools aiming at reducing credit dynamics. For example, they are an alternative to more distortive quantitative restrictions such as credit ceilings.

  • Second, RRs on foreign or domestic banks’ borrowing can help contain systemic risks by improving the funding structure of the banking system in a manner similar to what is pursued by some of the liquidity requirements proposed under Basel III (see Chapter III in this volume). They can reduce dependence on (short-term) external financing or wholesale domestic funding, reducing vulnerability of the banking sector to a rapid tightening in liquidity conditions. Peru’s active management of RRs on foreign liabilities with maturity lower than 2 years provides evidence on how RRs on banks foreign credit lines can change the composition of banks’ foreign borrowing in a juncture of large capital inflows (see annex).

  • Third, they can serve as a tool for credit allocation. At times of stress, an asymmetric use of RRs across instruments, sectors and financial institutions can help direct credit to ease liquidity constrains in specific sectors of the economy that threaten to have systemic implications (e.g., Brazil). In other instances is systemic risks are evident, marginal RRs can be applied to control the volume of bank credit stemming from the funding linked to the issuance of certain instruments (e.g., certificate deposits).

  • Fourth, RRs can play a useful complementary tool for capital requirements in countries where the valuation of assets is highly uncertain—because of a lack of liquid secondary markets, for example—as the true measurement of capital also becomes less certain.

  • Fifth, they have also been employed as a bank capitalization tool. In times of stress rather than lowering RRs, governments can increase their remuneration to help capitalize banks in times of stress (e.g., Korea—see below)

  • Finally, they can substitute some of the effects of monetary policy to achieve macroprudential goals. For example, this is evident when large capital inflows foster rapid credit expansion and put the credit cycle at odds with monetary goals. In such instances, RRs may substitute for increases in policy interest rates (e.g., Peru).3

However, RRs are no free lunch. They have costs and may introduce distortions in the financial system. RRs limit banks’ funding and also, if remunerated below market rates, act as a tax on banks. In response, banks may raise the spread between lending and deposit rates, which may stimulate banking disintermediation, increasing nonbank financing, and giving rise to excessive risk–taking in other less regulated sectors. Also, RRs can reduce credit through the effect on bank’s funding, especially if RRs are binding (for example, for banks that do not have sufficient reserves). RRs can also generate incentives for regulatory arbitrage. In some instances, such incentives materialize in the form of a proliferation of weakly regulated “bank-like” institutions, such as off-shore banks.

Their design is complex. RRs are a blunt instrument whose calibration is not straightforward given the many variables that need to be considered. This may include deciding which banks’ liabilities (deposits or nondeposits) to target, their holding period, the RR rate itself, whether to remunerated them or not, and how to calculate and constitute the base for the regulation (e.g., lagged or contemporaneous). Also, if RRs are modified along the economic cycle, consideration needs to be given to changes in the rate and changes in the reference period. For example, changes in the marginal rate could have mostly a signaling effect; while changes in the reference period could have a higher effect on banks’ liquidity. Furthermore, marginal RRs can have adverse effects on certain institutions in the market depending on the timing in which the requirement is imposed. Finally, and no least, their level have to balance monetary and financial stability goals.

B. Theoretical Considerations

Effects of RRs on the cost and availability of credit is determined by the banking system’s market structure, the degree of financial development, and the design of RRs themselves. The market structure determines the interest rate spread and where does the burden of RRs fall on: the loan or the deposit rate. In general, changes in RRs will pass-through in whole or in part to lending interest rates in those markets where banks have some monopoly power. The extent of pass-through to lending interest rates, and hence, the amount of credit will also depend on the remuneration set for RRs. Setting aside some of these issues, it is possible to calculate the impact of RRs on interest rates using an accounting approach (Box 1).

Effect of Changes in RRs on Active Interest Rates1

The impact of RRs on active interest rates can be estimated by taking the change in the required reserved times the spread between deposit and RRs remunerated rates relative to the portion of deposits not affected by RRs.

Specifically, let’s define a bank’s net margin, nm, as the return of each monetary unit lent at an active rate, ia, net of reserve requirements (1-rj), plus the return obtained by the reserve requirement itself, ir, and adjusting it by the portion of unremunerated reserve requirements, i.e. ia*(ij-ijnr), minus the passive rate. Then, the effect of changes in RRs on active rates required to maintain the net margin is:

1 See Quispe and others, 2009.

The impact of RRs on credit and interest rates depends on the monetary regime in place. In a monetary aggregates regime, RRs have a direct effect on the money multiplier and, therefore on monetary aggregates and credit.4 However, in an IT regime, the effect is not obvious as the central bank stands ready to offer the liquidity necessary for the market to clear at its short-term policy rate. If central bank credit is a close bank funding substitute of deposits, higher RRs will lower deposit rates, keeping lending rates unchanged. But if this condition is not met (because it exacerbates banks’ maturity mismatches or there is uncertainty on the path of future policy short–term rates), then RRs would lower the volume of credit and drive lending interest rates up (Betancourt and Vargas, 2008). This stresses the role of imperfect substitutability across instruments and markets as a necessary condition for RRs to be effective.

RRs can be a useful instrument to bring the interbank rate close to the policy rate in situations of excessive liquidity or stress in the financial system. If banks are deposit–price takers but have some market power in lending, a hike in policy rates makes central bank credit more expensive. This forces banks to rely more on deposits, causing deposit interest rates to move up. Since the marginal cost of funds for banks increases, credit supply declines, and lending rates also increase. In this context, and as long as deposits and central bank credit are imperfect substitutes, the raise in RRs would also reinforce the transmission channel.5

Empirical evidence supporting the effectiveness of RRs as a macroprudential tool is scarce. The lack of knowledge contrasts with the wide use of this instrument to manage the credit cycle and liquidity, which suggests some effectiveness (see discussion below). An adequate empirical assessment requires constructing appropriate aggregate empirical measures beyond the deposit-specific ratios. Vargas et al. (2010), for example, construct for Colombia a tax equivalent of reserve requirements based on observed required reserve ratio; which allows considering simultaneously the effects of average and marginal reserve requirements.6 Other studies for Brazil suggest that changes in RRs on time deposits had effects on the stocks returns of the banking system. In particular, the evidence indicates that non financial corporations were the most affected by these measures, thus implying that the tax burden can be borne by bank shareholders (Carvalho and Azevedo, 2008).

C. Conclusions

RRs are a flexible and effective macroprudential tool that can address the procyclicality and, to some extent, the interconnectedness dimensions of systemic risk. RRs can address issues arising from the procyclicality of the credit cycle, building a buffer in good times that can be deployed in bad times when liquidity is required. When targeted at nondeposit liabilities it can also help improve the funding structure of the banking system, thus building a cushion in good times and diminishing the exposure of banks—and therefore the extent of interconnectedness—of the system in bad times. Thus, under the current juncture of excess liquidity in global markets and large capital inflows to emerging market economies (EMEs), RRs on banks can be a useful policy tool to “lean against the wind” and avoid the buildup of imbalances, in particular, associated with excessive banks’ reliance on cheap and volatile funding. Another positive aspect is that RRs also allow for targeted intervention, avoiding distortion in market or segments not affected by exuberant conditions. Finally, RRs are a useful substitute to achieve the goals of monetary policy, even in IT regimes, in particular when monetary and financial stability goals are at odds with each other.

Nonetheless, RRs have costs. Their use can induce disintermediation both through raising lending interest rates and lowering credit availability. Also, they are difficult to calibrate. Finally, as with other macroprudential tools their use needs to be complemented with other measures as it can induce risks to shift from regulated segments or sectors to unregulated ones.

Country experiences confirm that RRs have been very effective as a countercyclical tool. The reviewed experiences (see Annex 1 and 2) indicate that authorities have raised RRs during the upswing and lowered them during the downswing to ease liquidity constraints—both before and after the global financial crisis. Moreover, to avoid distorting markets or segments not affected by over-exuberant conditions, RRs “lean-against-the-wind” in specific sectors of concern at specific junctures. Finally, so far the evidence seems to suggest that RRs applied in a macroprudential do complement well monetary policy. Nonetheless, more analysis is still required, in particular in general equilibrium settings.

Going forward, policymakers may be required to revisit the calibration and scope of RRs to enhance their usefulness as a countercyclical tool. Regarding the calibration of RRs, it is important to note that exorbitant RRs rates applicable to deposits can quickly lead to disintermediation. The RR coverage should also be part of the RR design. Indeed, some EMEs are facing strong domestic growth and credit dynamics that may prove unsustainable over the medium term, despite a proactive use of RRs on deposits and/or external liabilities. One reason may be the diversion of banks’ funding from standard to more innovative sources—e.g., reliance on credit lines from non-banking financial institutions. Unlike deposits and foreign credit lines, this source of banks’ financing has not been yet subject to RRs. Expanding the coverage of RRs to loans from domestic non-monetary corporations could help limit excessive reliance of banks on these as source of funding, and reduce network risks within the domestic financial system.

Annex 1. Country experiences with Deposit Reserve Requirements


Historically RRs in Brazil have been very high and complex. Their coverage varies over deposit instruments (Table A1), and their remuneration depends on the period over which they are applied and types of deposits. Operationally, compliance of RRs has been fulfilled with cash, and in some instances with government securities.

Table A1.

Characteristics of Reserve Requirements in Brazil

article image
Source: Central Bank of Brazil.

Can be complied with public debt securities.

Large banks can request eliminate this requirement through the purchase of smaller banks’ assets, and can eliminate 20 percent of the requirement by conducting foreign currency purchases at the central bank.

During the crisis, the Central Bank of Brazil (BCB) employed RRs as a mechanism to support financial stability through liquidity provision and credit reallocation (Table A1). First, the central bank increased liquidity in the market for bank reserves and for federal government bonds through a reduction of the mandatory reserves requirements on financial institutions. Second, it used them as an incentive mechanism—operating through the reduction of RRs—to stimulate the distribution of liquidity from large financial institutions to smaller institutions. In December 2008, large banks could be exempted from RRs on term deposits if they purchased assets of smaller banks, and they were also allowed to discount 20 percent of their RRs if they purchased foreign currency at the central bank. Third, a new type of term deposits with special guarantees was introduced through the Deposit Insurance Institution (Fundo Garantidor de Créditos -FGC) so that institutions relying on this instrument could benefit from a reduction in RRs. Finally, it became mandatory for financial institutions to extend rural credit, which was financed through a reduction of RRs.

Lately, RRs have served as a tool for managing the boom. Recently, RRs on deposits were increased beyond levels prevalent prior to Lehman’s episode. Furthermore, in January 2011, the BCB introduced new RRs that seek to limit the short dollar position of banks in the spot market (see companion note “Limiting net foreign exchange positions” by Fernández-Valdovinos and Walker). This measure also aims at discouraging carry trade operations and moderate short-term appreciation pressures on the real.


The Central Bank of Colombia (Banco de la República, BdR) has employed RRs over the cycle to slowdown credit growth in the context of large capital inflows. BdR introduced marginal RRs on domestic deposits (CDs, checking and savings accounts) in May 2007 to contain the rapid credit growth in the economy and stop the quality deterioration of new vintages of loans (Table A2). Credit dynamics seemed to be driven by a supply shift. This prompted measures to curtail the excessive leverage of the private sector and control credit risk of the financial system. RRs on domestic deposits were complemented with RRs on foreign indebtedness (see accompanying note on “RRs on capital inflows”), and higher loan provisioning requirements.

Table A2.

Characteristics of Reserve Requirements in Colombia

article image
Sources: Banco de la Republica; and Betancourt and Vargas (2010).

Marginal reserve requirements are not remunerated;

Applies since mid-August 2008.

Applies since February.

During the global crisis, RRs served a preventive role for liquidity provision. RRs were lowered and marginal reserve requirements were eliminated in the third quarter of 2008 when the economy began to show signs of a slowdown and the global business environment became very uncertain. These adjustments were complemented with further easing during 2009 (Table A2). Overall, RRs have varied over cycle, and authorities have applied them over different instruments. In some instances, marginal RRs have also been employed (Table 2).7

Econometric evidence suggests that RRs operate by making financial intermediation more expensive and that they have been a relevant determinant of business loan interest rates. Furthermore, that they have strengthened the interest rate pass-through from policy to deposit rates and to lending rates. Specifically, evidence for the period 2002–09 indicates a positive long run relationship between policy rates and market rates-except for mortgage rates. The evidence also suggests that marginal RRs on CDs have a significant impact in the longer term and average CD rates, even though CDs have zero RRs. This result may imply that RRs induce a shift in the composition of the deposit structure (Vargas et al, 2010).


The authorities proactively used RRs on deposits on prudential grounds and as a complement to monetary policy during the previous economic upswing. In 2008, with an overheated economy, large short-term capital inflows, and ample liquidity conditions in the financial system, the central bank used RRs as a complementary instrument to tighten the monetary stance and to reduce rapid credit growth (which peaked at about 40 percent y/y). The authorities noted that their strategy in dealing with strong short-term capital inflows through higher RRs earlier in 2008 was appropriate in buffering the IT framework from the risks to financial stability posed.

During the global crisis reductions in RRs were applied to preserve stable liquidity conditions and ward off the economy from a sharp and sudden slowdown in domestic demand. Decreases in the RRs helped reduce the deviation of the interbank rate from the policy rate. The authorities noted that if required, easing of monetary conditions could be achieved through lower RRs rather than through interest rates. Furthermore, they realized that reductions in RRs and policy interest rates along with fiscal easing, was the dominant strategy for managing downside risks. In general, the authorities felt that the deterioration of global financial conditions was better managed through RRs, leaving interest rates exclusively to control inflation. However, they stressed that they would not hesitate in relying on such instrument again to preserve financial stability, specifically to contain excessive credit growth and risks posed by dollarization.

The strong economic rebound observed since 2010 has led authorities to rely more heavily on RRs to curb rapid credit growth and tighten monetary conditions. Although policy rates have been hiked from 1.25 percent in early 2010 to 3.5 in February 2011, in the context of large capital inflows, this policy has the risk of attracting more capital inflows and carry trade operations. In turn, the central bank has proactively used RRs to limit liquidity conditions in the banking system (see text figures), and tightening the monetary stance. In January 2011, the central bank included credit channeled through off-shore branches of domestic financial institutions into the computation of RRs.

Figure A1:
Figure A1:

Peru’s Experience with Reserve Requirements on Bank Deposits

Citation: IMF Working Papers 2011, 159; 10.5089/9781455297726.001.A006

Source: Reserve Central Bank of Peru

In Peru, RRs apply to all types of deposits. Higher RR rates for foreign currency deposits are justified on prudential grounds given the high degree of dollarization of the economy and the central bank’s inability to print foreign currency in times of liquidity shortages.8 To calculate RRs, financial institutions first identify the total liabilities subject to RRs, and then compute the daily average for the month. Legal RRs rate apply to this daily average. For the marginal rate, the average in the month is compared to the one during the reference period (currently December 2010). The marginal requirement is then applied to the excess, and remuneration is depicted in Table A3. The sum of these two components is the total RR, and the implicit rate is the average rate for the RRs.9 Banks are allowed to have RRs above or below the minimum required. In case of a shortage, the institution is fined, and if it is recurrent, the institution can be taken into a special monitoring regime of the Superintendence.

Table A3.

Peru: Deposit Reserve Requirements, February 2011

article image
Source: BCRP.

For residents. The marginal rate for nonresidents is 120 percent.

Peruvian authorities report that a 1 percentage point increase in RRs rate has an equivalent effect over the output gap as a 25 bps increase in the policy rate.10 Also, a 1 percentage point increase in the RR raises one-year interest rates by 0.24 percentage point and decrease passive interest rates.


During 2010, the Chinese authorities’ raised RRs amid growing concerns about accelerating inflation and rapid money and credit growth. Domestic demand has been boosted by commercial banks’ frontloading of lending since early 2010, and continued strength in FX inflows provides additional liquidity to the real economy.11 Against this background a consensus has emerged on the need to tighten policy further. Given that large scale changes in market-based tools (e.g., interest rate and exchange rate) would be needed to cool down the economy are unlikely, most of the heavy lifting has fallen on administrative measures. RRs are considered a better alternative to price controls, which tend to send distorted signals.

Hikes of RRs aim at signaling the central bank’s tightening policy stance. The central bank hiked RRs 100 bps since January 2011 to 20 percent for large banks and 18 percent for small banks, representing the fourth tightening in two months. This was estimated to be equivalent to a reduction of Y360 billion in deposits (0.9 percent of 2010 GDP). Goldman Sachs estimates that the RR ratio is not binding on commercial banks’ ability to lend as the excess reserve ratio is estimated to be between 1.5 percent and 2 percent.12

Figure A2:
Figure A2:

China’s Management of Reserve Requirements

Citation: IMF Working Papers 2011, 159; 10.5089/9781455297726.001.A006

Source: People’s Bank of China


In December 2010, the Central Bank of Turkey (CBT) increased and broadened the scope of domestic currency RRs, with the aim of increasing the cost of short-term funding for domestic banks and limiting domestic credit expansion. However, reports indicate that timid RRs hikes will be insufficient to rebalance the economy, in the absence of a strong counter-cyclical fiscal policy response and given the easy domestic financial conditions, which are reinforced by low nominal rates and a weaker exchange rate.

The central bank also lowered policy rates with higher RRs. To enhance financial stability, the scope of the RRs was widened to include some repo operations,13 and to encourage long term funding RRs ratios were set to differ across domestic currency deposits with different maturities. Specifically, RR ratios—previously set at 6 percent—were set as follows: (i) 8 percent for demand deposits, notice deposits, private current accounts, deposits accounts up to 1-month maturity and liabilities other than deposits accounts; (ii) 7 percent for deposits accounts up to 3 and 6-month maturity; (iii) 6 percent for deposits accounts up to 1-year maturity; (iv) 5 percent for deposits accounts with 1-year and longer maturity and cumulative deposits accounts. To ensure the effectiveness of the policy, interest rates on demand deposits were capped at 0.25 percent annually. The new measures are expected to reduce market liquidity by approximately TL7.6 billion and US$200 million (0.7 percent of 2010 GDP, 2.3 percent of 2009 total claims to the private sector).


The Bank of Korea (BoK) used RRs during the crisis as a tool for capitalizing the banking system and therefore boosting its lending capacity. Thus their use had a different goal than in Latin America. Specifically, in December 2008, the BoK increased the banking system capital adequacy ratios by paying a one-off interest of W500.2 billion on RRs (0.05 percent of GDP). The advantage of this measure, rather than simply lowering banks’ RRs, was that it immediately improved bank balance sheets.

Annex 2. Country Experiences with Reserve Requirements on (noncore) Liabilities

The central bank of Peru has also been active in managing RRs on banks’ foreign borrowing in recent years. In September 2007, amidst a surge in capital inflows and with the objective of lowering the vulnerability of the banking sector to capital reversals, the central bank exempted long-term foreign borrowing from the reserve requirement—30 percent at the time—that applied to banks foreign liabilities. As a result, the composition of banks’ liabilities improved, with the banking system becoming less vulnerable to capital reversals. Foreign long-term liabilities as a percentage of total foreign bank liabilities increased from 22 percent in September 2007 to 58 percent in September 2008, and further to 82 percent in September 2009. During 2008, the RR on short-term foreign liabilities was increased and then eliminated in late-2008 to ease liquidity pressures from the global financial crisis.14,15 In early 2010, renewed inflows led the central bank to re-install the RRs on short-term foreign liabilities (Figure A2.1).

Figure A2.1:
Figure A2.1:

Peru RR on Banks’ Foreign Liabilities

Citation: IMF Working Papers 2011, 159; 10.5089/9781455297726.001.A006

Source: BCRP and authors’ calculations1 In January 2011, reduced to 60 Percent from 75 percent, while extending the coverage to foreign liabilities through off-short branches of domestic banks.2 More than 2 years.
Table 1:

Selected Operational Features of Reserve Requirements in Latin America

(as of early 2010)

article image
Source: IMF on surveys conducted in 2010.

Law allows to have different rates,

The minimum RR is uniform and there is a marginal RR for foreign currency liabilities,

with the exception of short term external financing of banks which are subject to 35 percent of RRs,


The actual base period is November 2008,

if the loans come from a Bank which is resident or from the Central Bank, Y for loans from foreign banks

In the same currency than the deposit if the amount of foreign currency deposits is either greater than U$S 10.000.000 or 5% of the total amount of liabilities in foreign currency. Otherwise, the denomination of reserves can be in US dollars,

Lagged at the same base as the RR only for domestic currency,

Only deposits at the reserve account,

Only for leasing companies

Table 2:

Selected Operational Features of Reserve Requirements in Asia

(As of early 2010)

article image
Source: IMF on surveys conducted in 2010.
Table 3:

Selected Operational Features of Reserve Requirements in Europe

(as of early 2010)

article image
Source: IMF on surveys conducted in 2010.

2% for EUR, 0% otherwise;

with original maturity up to 2 year;

only in EUR;

D for Nonresidents Deposits F for Residents Deposits;

50% of cash in vault;

for scheduled banks Y, for non-scheduled banks.

Government deposits are 100% collateralized by government bonds.


Prepared by Mercedes Garcia-Escribano, Camilo E. Tovar, and Mercedes Vera-Martin. We appreciate comments by S. Phillips, G. Terrier, R. Valdés, and C. Walker.


Benefits are not necessarily additives and may exclude each other. For a general overview of the macroprudential policy discussion see IMF (2011d and 2010c).


RRs are also a complementary tool for foreign exchange sterilization. In periods of large capital inflows, RRs can substitute open market operations as a tool to sterilize central bank foreign exchange intervention, thus reducing their quasi-fiscal effort (especially if RRs are unremunerated).


With financial development, the role of a money multiplier and its relevance has changed. If banks are able to securitize loans, the total quantity of loans available to the banking system is not longer less than the total amount of money in deposits, as bank-originated lending can exceed the total amount of money on deposits.


More analysis is required to formally evaluate the role of RRs, in particular, in a general equilibrium setting.


Although this is a good approach for capturing liquidity changes, the approach fails to measure correctly the changes in the marginal cost of bank funds and market interest rates, and may over/underweight the role of marginal RRs.


The range of deposits subject to RRs is includes checking accounts, simple accounts, savings, real savings, special savings, centralized accounts, different transfer agreements on repo operations, some term deposits, some bonds, certificate deposits, and other more specific items.


In some instances, local currency–denominated deposits are exonerated, for deposits of S/ 50 million or 5.6 percent of the total liabilities subject to RRs, whichever smaller.


As of September 2010, this average rate was 9.1 percent for domestic currency deposits and 36.9 percent for foreign currency deposits. As of October 2010, the stock of domestic-currency RR amounted to S/. 6.9 billion (1.6 percent of 2010 GDP). Notice also that there is no substitutability among assets denominated in either currency.


This result is calculated using a framework similar to that described in footnote 10, and is based on an active average rate of 19.5 percent, a reserve requirement of 6 percent, and no RR remuneration.


External demand has also been accelerating as well, adding fuel to aggregate demand pressures; and short-term food prices have started to rebound amid adverse weather conditions.


Going forward, for the year as a whole, analysts are expecting at least 200 bps in RR hikes owing to concerns about surging FX inflows, price pressures, and bank lending. Consecutive RR hikes will likely make it more difficult for them to keep lending at a fast pace.


The RR base was expanded to include funds received by banks through repurchase agreement (repo) transactions from abroad and domestic customers, except for those funds received from repo transactions with the Central Bank and those among domestic banks.


The reserve requirement on long-term foreign credit lines was re-established in August 2008 and eliminated in October.


In addition to the RR management, the central bank introduced a fee to the transfer of Bank certificates.

Policy Instruments to Lean Against the Wind in Latin America
Author: Mr. G. Terrier, Mr. Rodrigo O. Valdes, Mr. Camilo E Tovar Mora, Mr. Jorge A Chan-Lau, Carlos Fernandez Valdovinos, Ms. Mercedes Garcia-Escribano, Mr. Carlos I. Medeiros, Man-Keung Tang, Miss Mercedes Vera Martin, and W. Christopher Walker