Inflation report - attachment
II/2001

Escape clauses pertaining to the new inflation target

The reserve requirement has been part of the CNB's range of monetary policy instruments since the bank was established. Its significance and parameters have changed over time in keeping with the changes in the monetary policy management scheme and the development of the money market and monetary instruments. The reserve requirement was of greater significance in the first half of the 1990s, when the CNB managed the volume of funds using monetary aggregates and when the money market and monetary instruments were just developing, than it has been in subsequent years. The relatively high reserve ratio (an order of magnitude higher for demand deposits than for time deposits) and the fact that the required reserve holdings were not remunerated enhanced the effectiveness of the instrument in suppressing deposit multiplication. Under conditions where the money market and monetary instruments were not fully developed, the CNB confronted the risk of higher volatility by shortening the maintenance period to two weeks and by introducing a limit for the inclusion of end-of-day balances on settlement accounts in reserve requirement compliance. The development of money market instruments raised the need to adjust the reserve base (i.e. the eligible balance sheet items constituting the basis for calculating the reserve requirement of an institution) from time to time.

The significance of the reserve requirement as a monetary instrument gradually declined in the second half of the 1990s. The switch from managing the volume of funds to managing their prices at the beginning of 1996, and the abolition of the privileged position of monetary aggregates in monetary policy management following the introduction of inflation targeting at the start of 1998, considerably weakened the monetary policy function of the reserve requirement. The development of the money market and monetary instruments also negated the need for intensive use of the stabilisation function of the reserve requirement (i.e. to smooth interest rate volatility and stabilise the money market). In these conditions, it was no longer necessary to maintain a high reserve ratio. Coupled with the fact that the reserves were not remunerated, the high ratio was reducing the competitiveness of domestic banks compared with the domestic and foreign entities active on the domestic deposit and credit markets (who were subject to a lower or zero reserve requirement). The development of the money market and monetary instruments also gradually established conditions for abolishing the limit for the inclusion of end-of-day balances on settlement accounts in reserve requirement compliance and for extending the maintenance period.

In this context, fundamental changes were made to the reserve requirement parameters. First, the reserve ratio was lowered in order to create a level playing field and boost banks' competitiveness. At the start of 1997, the CNB cut the ratio from 11.5% to 9.5%, and in mid-1998 it formulated a medium-term programme to reduce it further. This was done in three steps: to 7.5% effective 30 July 1998; to 5.0% effective 28 January 1999; and to 2.0% effective 7 October 1999. Simultaneously, the preferential 4% ratio for building societies and Českomoravská záruční a rozvojová banka (the Czech-Moravian Guarantee and Development Bank) was abolished. A uniform ratio applies to all the credit institutions in the reserve requirement regime.

Lowering the ratio to 2% aligned the reserve requirement with European Central Bank standards. During the course of 2000, the CNB examined the possibilities for harmonising some of the other reserve requirement parameters. The following harmonisation steps were subsequently announced:

  • Effective 22 February 2001, the limit for the inclusion of end-of-day balances on settlement accounts in reserve requirement compliance was abolished. This limit is no longer justified given the currently small volume of required reserve holdings and the advanced state of development of the money market.
  • Effective 12 July 2001, the reserve base will be adjusted so that only liabilities vis-a-vis non-banks the maturity of which does not exceed two years will be subject to the reserve requirement (at present, all primary deposits and credits accepted from non-banks and issued securities with agreed maturity up to five years held by non-banks are included). The adjustment of the reserve base on this date has been made possible by adding a separate item "liabilities not exceeding two years" to the ten-day survey of the stock of bank assets and liabilities used in the reserve requirement calculation.
  • Effective 12 July 2001, remuneration of the holding of required reserves at the rate of the CNB's main repo operations (currently the two-week liquidity-withdrawing tender) will be introduced. Reserve holdings exceeding the required reserves will not be remunerated. The remuneration rate is broadly in line with ECB standards.
  • Other harmonising steps in the reserve requirement area are planned. These involve, for example, harmonisation of the monthly assets and liabilities balance sheet with the ECB standard - the data necessary for setting the reserve base within the monthly cycle will be included. A zero reserve ratio on liabilities ensuing from repos will also be set.

The implementation of these adjustments will bring the minimum reserve system in the Czech Republic much more into line with ECB standards. In the period ahead, the CNB will lay the groundwork for fine-tuning of the minimum reserve system in the Czech Republic. The tasks include in particular clarifying the issue of inclusion of cash in the reserve requirement, harmonising the range of institutions subject to the reserve requirement, and specifying in more detail the procedure for applying sanctions in the event of non-compliance with the minimum reserve obligations.