BSP hikes regular reserves to 9 percent; interest rates steady

(Updated 8:03 p.m.) The Bangko Sentral ng Pilipinas (BSP) policy board has opted to keep interest rates at present levels, but reduced inflation pressures by raising the reserve requirement of banks by one percentage point. “In deciding to maintain policy rates, the Monetary Board noted that the latest baseline forecasts show a lower path and that inflation expectations have shown signs of leveling off," the BSP said. The BSP decided to use another policy tool at its disposal to head off a possible increase in liquidity levels. It raised to 9 percent from 8 percent the regular reserve requirement on bank deposits and deposit substitutes. The level of liquidity reserves for banks stays at 11 percent. “The Monetary Board believes that expectations of continued strong capital inflows driven by positive market sentiment over the favorable prospects for the Philippine economy could fuel domestic liquidity growth and contribute to inflation risks," the BSP explained. Banks and non-banks with quasi-banking functions must comply with the new reserve requirement starting Friday, June 24. Reserve requirements are the chunk of funds in the form of bank deposits and deposit substitute liabilities that banks may not lend because these must be kept on hand or in deposits with the BSP. The required reserves consist of regular or statutory reserves and liquidity reserves. The BSP said the adjustment in the reserve requirement is part of the “normalization of liquidity-enhancing measures adopted during the global financial crisis." BSP officials hinted of eventually raising the reserve requirement to levels way back in January 2010. Impact on liquidity BSP Governor Amando Tetangco Jr. has said that every percentage point in the reserve requirement accounts for about P30 billion of liquidity. “Domestic liquidity or M3 reached P4.2 trillion in April 2011, wide by 7.3 percent from the year earlier levels. The seasonally-adjusted M3 contracted by 0.6 percent from a growth of 1.4 percent in the previous month," the BSP said last week. The New Central Bank Act (RA 7653) empowers the Monetary Board to require all banks and quasi-banks to maintain reserves. The law does not require the BSP to pay interest on reserves deposited with the BSP. “Since the requirement to maintain bank reserves is imposed primarily to control the volume of money, the Bangko Sentral shall not pay interest on the reserves maintained with it unless the Monetary Board decides otherwise as warranted by circumstances," according to RA 7653. The BSP pays 4 percent a year on deposits maintained by banks with the BSP, while liquidity reserves are paid the rate on comparable government securities. According to economists, reserve requirements "add to banks' intermediation costs and act as a tax on intermediation." RA 7653 also provides that banks’ and quasi-banks’ reserve positions “shall be calculated daily on the basis of the amount, at the close of business for the day, of the institution's reserves and the amount of its liability accounts against which reserves are required to be maintained…" The BSP Department of Economic Research has explained that there are five main tools the Monetary Board can use to manage liquidity and achieve inflation targets. The reserve requirement and the overnight lending and borrowing rates are often employed. The BSP can also increase or decrease rediscount rates on the loans it extends to banks. Special deposit accounts and BSP holdings of government securities are also tools to manage liquidity. The 2011 inflation target is 3 percent to 5 percent.— Earl Rosero/VS, GMA News