Friday, March 9, 2012

Reserves, Deposits and Loans

Some days I feel like tearing my hair out. It seems like so many people are living in a past that just doesn’t exist anymore. It’s one thing for a layman not to grasp the intricacies of macro-economics – but its quite another for analysts and economists to make basic mistakes. And even worse if its a policy maker.

I fully understand how Hafiz Noor Shams feels.

So what brought this on? I was talking to a government official on the subject of illicit money flows (sorry, can’t say who, where or when), and he said the outflow of capital would result in a decrease in international reserves. Since we were talking about corporate transfer pricing, which is mainly about discretionary choice of tax jurisdiction (i.e. no cash flows involved), I was, to put it mildly, somewhat flummoxed.

Then this came out in the paper a couple of days ago (excerpt):

The importance of having quality loan growth

...Noting that reserves have remained at RM420bil for a few months, analysts already expect banks to start pulling back on lending even in the absence of the guidelines.

When reserves, which are ringgit deposits, are high, banks would usually try to lend more.

As the accumulation of reserves has flattened, the result is the slowing of deposits.

Hence, the slowing of lending activities, in a sense, was aggravated by the imposition of the guidelines...

OMG, OMG, OMG where to begin?

RM420 billion refers to international reserves, which are not “ringgit deposits” – what the hell do international reserves have to do with bank lending?

The level and change in reserves ONLY effects credit growth under a fixed exchange rate regime or a currency board, but ONLY if the central bank does unsterilised intervention and ONLY if banks respond to the higher liquidity conditions by chasing yield (i.e. lending more AND/OR buying higher yielding securities).

The link between international reserves and liquidity conditions in the banking sector doesn’t exist under a floating rate regime such as Malaysia operates today – central bank intervention under those circumstances is purely discretionary, hence changes in reserves signals absolutely nothing about future lending or banking sector liquidity.

Even under a fixed exchange rate regime, the influence is conditional and the causality runs the other way – higher reserves signals (i.e. is caused by) higher liquidity, not the other way around.

But lets take the idea that higher ringgit deposits leads to higher lending at face value – but that’s wrong too, though I’m less inclined to blame anybody for getting this wrong (econs textbooks don’t exactly make this clear either).

Again, the causality runs the other way. Lower loan growth leads to lower deposit growth, not the other way around. Each loan granted is its own deposit – banks don’t need pre-existing deposits to lend money out, they just need to balance their assets and liabilities.

Malaysia shifted to a floating rate regime in 2005 – why are people still thinking in terms of a macro environment that was fundamentally changed 7 years ago? And thinking of banking and lending in a way that hasn’t existed in reality for very nearly a 100 years?

I think I’m going to turn bald before I hit 50.


  1. Was the article perhaps referring to banks' reserve requirements imposed by the Central Bank. Even then, however,this sentence - "With the easing in the accumulation of reserves and strict adherence to lending guidelines, loan growth may hit 8% or less sometime later in the year" - wouldn't make sense.

    I fully sympathize with your sentiments. Everyone is a social scientist. A layperson wouldn't deign to comment on someone's complicated medical history or the technicalities of the structural integrity of a bridge, for instance.

  2. I have white hair, and I'm still in my 20s.

  3. @anon

    Stat reserve is about RM35 billion, and excess reserves are only about RM215 billion. It doesn't add up.


    Seems to be an occupational hazard :)

  4. I'm balding. And I'm already fifty. But I still don't understand a word you're saying. You're one smart cookie. Cheers.