How Potent Is the Required Reserves Tightening Shock Impact on Funding and Consumer Interest Rates?

This chapter explores the effects of a required reserves (RR) ratio tightening shock and excess liquid asset holdings (LAH) on liquidity, funding and consumer interest rates. We establish the existence of an RR ratio cost channel, meaning that the tightening in the RR ratio imposes a cost on bank intermediation. The effects of the RR ratio on consumer and funding interest rates differ depending on the shock. The regulatory impact on banks’ deposit funding base indirectly assists the central bank in raising the money market liquidity. But this comes at the expense of a sustained increase in the spread of funding rates in the inter-bank, wholesale and government markets. The results show that to make the RR ratio policy effective and the transmission of policy changes, the South African Reserve Bank (SARB) has to re-look at the current approach of allowing banks to access their reserve deposits intra-month over and above the fact that they are not remunerated. Theoretically, if the RR deposits are remunerated at the going market rate, the RR ratio effects are rendered macro-economically neutral. The SARB will have to exploit the effects that regulatory changes and the structure of the banks’ balance sheet induce on the rand deposit funding base to make the RR ratio policy effective. If the SARB introduces (or phases in) the approach to restricting access to the RR deposits intra-month, this may make the RR ratio a binding constraint, thus making the RR ratio policy more effective. This means that there is a role for coordinating the financial regulation and monetary policy tools to achieve the desired.