It increased reserve requirements of five banks by 13% because they “didn’t abide by the rules governing their balance sheets,” the semi-official Fars News Agency quoted an informed source at the CBI as saying.
Reserve requirements not only guarantee deposits, but also serve as a CBI tool to control money circulation, inflation and money supply growth. The CBI determines the reserve requirement ratio of banks.
The central bank sets the ratio between 10% and 13% based on banks’ law abidance. This means that the regulator reduces the reserve requirement for disciplined banks from 13 to 10%.
Unruly banks don’t qualify for such adjustments. In short, the cut in banks' reserve requirements is a disciplinary tool to control lenders. Until recently, the reserve requirement for most banks was below 10%.
Economists say overexpansion of broad money supply is partly linked to balance sheets of banks. The CBI recently enforced disciplinary measures to control banks’ balance sheets.
As per a CBI bylaw, the monthly growth of specialized lenders’ assets must not exceed 2.5%. Likewise, commercial banks are not allowed to increase assets in their balance sheets above 2%.
According to regulations approved by the Money and Credit Council, the top monetary and policymaking body, assets shown in the balance sheets of banks are monitored at regular intervals. Supervision over lenders’ assets does not include all entries in their balance sheets.
The regulator is sensitive toward any upside in the balance sheets from investment in non-bank activities, increase in bank expenses, expanding branches and buying fixed assets.
Impact on Money Multiplier
On the flip side, the regulator says it is positive about increase in the balance sheets resulting from increasing capital, purchasing government bonds, cash reserves and the likes, as these items have little or no impact on the money multiplier.
The money multiplier measures the maximum amount of commercial bank money that can be created by a given unit of central bank money.
The money multiplier was 7.839 in mid-September, meaning that for every rial created by the banking system money supply increases by 7,839 rials.
Controlling banks’ balance sheets reduces the money multiplier, and by extension, curbs the expansion of broad money, which exceeded 40,680 trillion rials ($145 billion) by the end of the sixth calendar month on Sep. 22.
CBI earlier linked the rise in money multiplier mainly to the decline in the ratio of banks’ excess reserves to their deposits. Banks’ excess reserves declined from 304.1 trillion rials ($1b) in March to 192.7 trillion rials ($688 million) on Sep.22.
Recent CBI data show that the reserve requirement of banks has more than doubled in the past three years.
Legal reserves rose from 154 trillion rials ($550m) in fiscal 2017-18 to 354 trillion rials ($1.3b) by end of the last fiscal year (March 21), up 129% over three years.