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Advantages And Disadvantages Of Reserve

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Advantages and Disadvantages of High Reserve requirement

RRR is a central bank regulation that issued by the central bank to force banks working in the country to deposit a certain amount of its deposits with no interests at the central bank to cover any future risks that may arise. It is different from one country to another.

Reserve requirement works as a security net, and it is a paramount tool in managing liquidity in the market. But it can also have an adverse effect on the multiplier inside an economy.

Reserve Requirement Ratio adopted by many countries has many advantages. Some of these advantages are:

1) Prudential Advantage
Reserve Requirements ensure that banks hold a certain proportion of high-quality liquid assets. In the …show more content…

If the minimum fraction of commercial bank borrowing is to be covered by reserves like gold, then the availability of reserves like gold must necessarily limit bank borrowing, and thereby its capacity to lend. Credit funded by non–reservable liabilities would not be so constrained. Under a currency board system (or the gold—or other specie—standard), reserve money creation is limited by the requirement that it solidly be backed by specified assets. The central bank purchase of foreign exchange or gold provides an external backing to reserve money; the acquisition of government securities may also provide support, but is closer to secured lending. If the reserve creation is constrained, a bigger reserve requirement would then necessarily bring about a reduction in credit, while a lower requirement would undoubtedly increase it. This description does not clearly reflect modern central banking practice. Once “reserves” comes to mean “balances at the central bank,” the central bank can easily accommodate any increase in the demand for reserves—provided banks hold adequate collateral—since it can create …show more content…

If averaging of RRs is permitted, this can be a very effective way of supporting commercial banks’ own short–term liquidity management. Averaging of RRs can be useful especially when it is hard for the central bank to forecast accurately all flows across its balance sheet since averaging creates an inter-temporal liquidity buffer to offset errors in the central bank’s forecast. If an individual bank is indifferent whether it has a reserve balance for today or tomorrow, then it should be ready to lend in the interbank market. If the rates are above the level expected for the remainder of the RMP (since it would expect to be able to borrow more cheaply lately), or to borrow if rates are relatively small (since it would expect to be able to lend at a higher rate lately). Both of the said actions would keep overnight market rates at the targeted level. But indeed, a bank would never borrow when it was too expensive, or lend at a very low rate, if it could still vary its reserve level to adapt in the swings of liquidity. Because averaging help to balance supply and demand, it should reduce the impact of short–term and economically insignificant liquidity swings on overnight market rates. This liquidity benefit exists whether or not

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