Monetary Policy Committee Statement on changes to credit institutions’ minimum reserve requirements 4 April 2024
The Monetary Policy Committee (MPC) of the Central Bank of Iceland decided at an extraordinary meeting on 2 April 2024 to increase credit institutions’ fixed reserve requirement from 2% to 3% of the reserve base. The change will take effect at the beginning of the next reserve maintenance period, on 21 April.
One of the main premises for conducting independent and credible monetary policy is that the Central Bank must have sizeable international reserves. One of the roles of the reserves is to mitigate volatility in Iceland’s balance of payments, with reference to the Bank’s monetary and exchange rate policies. Furthermore, abundant reserves reduce the likelihood that movement of capital to and from Iceland will compromise financial stability. Moreover, the international reserves function as a reserve fund that can be tapped in the event of large and unexpected shocks that disrupt foreign currency generation. There are costs associated with such protection, however, and they increase as the interest rate differential with abroad widens. The costs are borne largely by the Central Bank, whereas other domestic stakeholders benefit from more favourable interest rate terms in foreign credit markets.
The decision to increase the minimum reserve requirement is part of the Central Bank’s comprehensive review of the interest rates the Bank offers its main counterparties. The increase aims to distribute more evenly the cost of conducting independent monetary policy and to ensure sustainable financing of Iceland’s international reserves.
Raising reserve requirements can affect the monetary stance, but given deposit institutions’ ample liquidity position with the Central Bank, the short-term effects of the change should be limited. In the longer term, however, it will provide a more solid foundation for monetary policy conduct, thereby enhancing the Central Bank’s credibility and promoting more effective monetary policy.
Press release no. 8/2024
4 April 2024