Thursday, February 10, 2011

SRR To Cool Hot Money Flows…Not

This one’s making a mountain of a molehill (excerpt; emphasis added):

Worries over SRR hike impact on loans

Statutory reserve requirement may be raised to curb hot money

KUALA LUMPUR: There are fears in the banking and finance sector that a hike in the statutory reserve requirement (SRR) to cool hot money inflow may impact loan activity and result in an economic slowdown.

Bank Negara's SRR, which is currently set at 1%, is the amount of money that all the country's commercial, investment and Islamic Banks must set aside and lodge with it.

“A 1% increase in the SRR rate could drain some US$1.3bil from the banking system, just a fraction of the funds available to the sector for lending purpose,” Oxford Business Group (OBG) said in its latest economic update.

Since December 2008, when the SRR stood at 4%, Bank Negara has implemented a series of reductions, with the current 1% introduced in March 2009.

On Jan 27, although the central bank left the key overnight policy rate (OPR) unchanged at 2.75%, it hinted at additional policy tools, such as the SRR and macroprudential lending measures, being considered to avoid the risks of macroeconomic and financial imbalances.

According to OBG, though only a relatively small amount, an increase in the SRR rate would send a message to the financial sector, and could cool the hot money flow.

The direct impact of any such rate increase on domestic lending has divided analysts, with some fearing it could prompt a more conservative approach by banks, thus reducing the gross domestic product growth...

Even passing over the bad grammar, I find this article (and especially the headline) a little silly.

Let’s review conventional theory: the SRR is a requirement by BNM for all banks to deposit a certain percentage of their loan assets with BNM at 0% interest rates. The idea is that the SRR regulates the amount of liquidity (excess cash) that the banking system can use to extend loans to customers. Since credit is the primary form of money creation in the economy, a higher SRR also reduces the capability of the banking system to create money (technically, it reduces the money multiplier).

The problem here is that the banking system has so much money sloshing around, that a 100bp hike just won’t have much effect. In the article itself we see OBG stating that a 1% increase would only yield a withdrawal of USD1.3 billion from the banking system.

So how much excess money does the banking system really have? More than enough to absorb multiple 1% increases, even if BNM was so inclined. Here’s the level of deposits that banking institutions keep at BNM (RM millions):


This in turn translates roughly into the following reserve ratio:


At one point, banks were keeping 30% of the value of their loans in cash at BNM – the current level is over 15%. As OBG says, a 1% hike in the SRR would be just a fraction of the excess funds available to banks. In fact, a hike in the SRR would be nothing more than a balance sheet entry at BNM, and won’t actually require a withdrawal of liquidity from the banking system itself.

I don’t think that the SRR will ever be an effective tool again, unless it starts to approach the level of reserves banks themselves are keeping aside; for example as in China, where the PBoC requires a 19% reserve ratio. Even then, it hasn’t noticeably dampened credit growth.

As further evidence, the loan to deposit ratio has been bottom-feeding for years:


Translation: banks have more deposits than they know what to do with.

And I completely fail to see how a hike in the SRR will curb hot money inflows, since those are exogenous to the banking system. The SRR might be used to reduce the excess liquidity that is caused by hot money flows, but it won’t reduce the capital flows themselves. In fact, as an indicator of future interest rate hikes it might actually boost them instead.

So why bother using it at all? It’s still useful as a signal of central bank intentions – “Look out, we’re watching you!” It’s also cheaper to use as a liquidity management tool than issuing BNM bills, as BNM pays no interest on bank reserves.

Which leads me to the speculation that BNM is contemplating following this route simply because of the mounting cost of open market operations. They’ve had to issue a massive amount of debt securities to support the increase in the OPR last year (RM millions):


That’s a hefty chunk of change to have to pay interest on, even if it is only yielding a few points above KLIBOR – something like near RM3 billion annually at current levels. Imagine how much more they’d have to pay if the Monetary Policy Committee voted to increase the OPR again later this year as everyone expects. That would mean more issuance of BNM bills, and at higher yields.

An SRR hike on the other hand, costs BNM nothing.

Note the differences between this year and last year when BNM started the last round of OPR increases. At that stage, BNM bills outstanding were around RM30 billion, at an annualised cost of around RM600 million. Now, BNM is maintaining three times the amount of securities outstanding and at about five times the cost, with the prospect of increasing both amounts and costs if they decide that another round of OPR increases was warranted.

Last year I didn’t think there would be an SRR hike – this year I think it’s inevitable.


  1. Malaysia is basically bankrupt with OIL as the resources that is keeping it from keeling under thats why the Government is so desperate to find new OIL reserves. Since most if not all oil palm and rubber estates have to sell their oil palm and rubber to the Government, they make a lot of money from commodities. But what a lot of people don't know is that they are not paying the suppliers of these palm oil and rubber, they are saying the Government has no money and ask them to wait. EPF is used by the Government as a Bail Out of any UMNO or crony that needs to get out of Malaysia should the opposition win in the next election. And UMNO ministers still demand a RM 500,000 jewellery for Hari Raya or RM 200,000 cheques Duit Raya or for their signatures on documents. Hence most Chinese Businessmen are running to China, Hong Kong, Thailand, Singapore, Australia, UK, USA, etc. and doing business there while closing down or scaling back their operations here in Malaysia. But the Government does not care, all it cares about is that it GETS ITS DUIT KOPI !!!

  2. "Since most if not all oil palm and rubber estates have to sell their oil palm and rubber to the Government, they make a lot of money from commodities."

    Sorry, what fantasy world are you living in? The only company for which this might be true is FELDA, but FELDA is a fraction of the market.

    And why are you posting off-topic?

  3. hahaha right on hisham. that anonymous is a dud.

  4. Thanks Hisham for a great article.

    Given that our banking system has excess reserves of around 15% vs. the current SRR of 1%, how much more in terms of SRR that BNM may have to hike in order to relieve the debt burden it currently faces?

    Does it make sense for such moves, i.e. tighten monetary policy but at the same time implement massive fiscal projects under the ETP and pass the burden of financing to the private sector (since it was mentioned before that public sector is not driving the financing)?

  5. Dear HishamH,

    This article is great and kudos to you for writing it.

    However some thoughts emerge

    (1) Why is the bank sitting pretty on a pile of cash?

    I think the answer has to be the huge almost titanic differential between cost of funds (deposit rate) vs. the BLR. I think the spread is like 400 bps, something which makes it very easy to be a banker and very crappy to be a consumer. So banks don't have to stretch to be profitable, just lend to the consumers and earn the differential

    (2) Should BNM raise rates?
    Well, from the "feel", the economy would have grown between 4-5% in Q4, and if raising rates cools off the economy, then it seems rather strange given the low GDP growth numbers. (esp with the growth in working age population)

    (2) At the same time is inflation growing out of hand? Is it? I don't know. I think you have written quite a lot on it, and the technicals say one thing, the "man on the street" feeling is another.

    (3) The article is great as it shows how using the SRR is a better alternative than using the OPR. However, as you quite rightly pointed out, moving the SRR by a couple of % points does nothing when the effective SRR is of orders of magnitude greater.

    Great work and my sincerest appreciation.

  6. Hello from Paris.

    Great insight, but I'm unsure if I agree about "we're watching you" point. The hike in requirement tells a message to the banks, not the owners of hot money. If the BNM is in mood of telling "we're watching you", then the BNM is telling it to the wrong side.

    The owners of hot money really care about the hike. It doesn't affect them by one bit, for reasons you've stated.

  7. anon 6.09

    You're very welcome.

    To answer your question I honestly don't know. It depends on two things:

    1. How much would a hike in SRR require a counterbalancing liquidity injection for BNM to maintain the overnight rate at the OPR target? i.e. what's the elasticity of the SRR relative to the overnight rate? I don't think BNM knows this either - it'll be trial and error.

    2. What level of debt is BNM comfortable carrying on its balance sheet? That's something only BNM can answer.

  8. Hi Wenger,

    Thanks for the kind words.

    1. Actually, I think BLR is becoming as irrelevant as the SRR. Average lending rates have been dropping for more than a decade, and last year were a full 100bp below the BLR. Taking the overnight rate as representative of the COF (I know that's a stretch), that gives an average loan margin of just 2.3%.

    Looking at other countries, a reserve ratio of 15% seems to be around the ballpark figure. There's some research I remember hearing about that pre-1972, banks kept reserve ratios close to the SRR, but the effective ratio has been rising ever since especially with financial liberalisation.

    I suspect regulatory liquidity frameworks are the reason banks keep their reserves high.

    2. Last year was a recovery year so slower growth this year isn't necessarily an indication of a "slowdown", but more of a "back-to-trend". So if we see higher than 5% GDP, it's not necessarily a policy mistake to raise interest rates.

    3. On inflation, I think the real culprit is low wage growth, not rising prices per se. But that isn't something you can solve with monetary policy.

  9. Hi Hafiz, how are you finding the City of Light? You're taking some great pics, keep it up!

    Yes, I was actually thinking of the banks in that instance. Sorry, should have made that clear.

  10. Sorry anon 6.09, I missed your second question on whether raising interest rates makes sense.

    Given that BNM is ostensibly independent, the question you raise is exhibit No 1 as to why discretionary fiscal policy isn't considered effective in some theoretical circles, the well-known "crowding out" effect.

    Increased spending irrespective of consumption or investment, raises growth AND inflation expectations, leading to interest rate increases that reduce planned private investment, in turn leading to slower growth.

    So the real question regarding the ETP is whether the identified projects - and it doesn't matter here whether they're done by the public or private sectors - boost income and equalise income distribution more efficiently than the economy would have done in the absence of the ETP.

    You can't statistically or economically prove or disprove hypotheticals like that, but of such stuff are economics and political careers made of.

    I'm not going to pretend to know the answer, but as long as the outcomes are sufficiently welfare enhancing (higher GNI AND lower Gini Coefficient), I think that's enough to declare success. But if both goals aren't achieved, then we'll probably need a new New Economic Model.