An analysis on adequacy of effective reserve requirement ratio in Korea

This study examines the adequacy of Korea's effective reserve requirement ratio (defined as the ratio of banks' Korean-won deposits held at the liability accounts of the Bank of Korea to their Korean-won deposits) and its potential use as a macroprudential policy tool, employing cointegration regression analysis and a Bayesian VAR conditional forecasting framework. The main findings are as follows. First, the effective reserve requirement ratio in Korea is found to exhibit a generally positive long-run equilibrium relationship with economic growth and the financial stress index. Second, projections of the ratio through 2045 based on the estimated cointegration coefficients indicate a gradual decline under the baseline scenario. Third, conditional forecasts for the next ten years using a Bayesian VAR show that maintaining the current level of 4.2% minimizes the sum of squared forecast errors, compared with scenarios in which the ratio increases or decreases by 1.5 percentage points. Fourth, Korea's reserve requirement system appears to have contributed to macroprudential stability by functioning as an automatic stabilizer that mitigates short-term liquidity fluctuations in the money market. In conclusion, the current level of the effective reserve requirement ratio does not deviate significantly from its equilibrium path and is expected to decline gradually in response to changing macro-financial conditions, including a slowdown in economic growth.