Change in credit institutions’ minimum reserve requirements
The Monetary Policy Committee of the Central Bank of Iceland has decided to change the arrangements for credit institutions’ minimum reserve requirements so as to divide the reserve requirement into two parts: a fixed 1% reserve requirement bearing no interest, and a 1% reserve requirement of the type that has been in place heretofore, currently bearing 4% interest. The objective of these changes is to reduce the cost to the Central Bank in implementing monetary policy while the international reserves are large and the interest rate differential with abroad is wide. These changes are not intended to affect the monetary stance.
According to the Act on the Central Bank of Iceland, the Bank “may decide that credit institutions shall be obliged to maintain funds in reserve accounts with the Bank.” The Act also stipulates that the Monetary Policy Committee shall take decisions on credit institutions’ minimum reserve requirements, which are considered one of the Bank’s monetary policy instruments.
According to the current arrangements on minimum reserve requirements, the reserve amount is 2% of the reserve base for each entity subject to reserve requirements (i.e., commercial banks, savings banks, and credit institutions as defined in operating permits granted by the Financial Supervisory Authority). The reserve base on which the minimum reserve requirement is calculated comprises deposits and bonds with a residual maturity of two years or less and issued by the undertaking concerned. The calculation is based on the average reserve base for the two months immediately preceding. The reserve amount is the minimum daily average balance that an entity subject to reserve requirements must maintain over the reserve maintenance period, which extends from the 21st day of each month through the 20th day of the month immediately following. Each entity concerned may decide how it will fulfil its reserve requirements on the basis of the Rules that pertain. This arrangement for minimum reserve requirements was based on the European Central Bank’s framework and has broadly been in use in Iceland for about two decades. The interest rate on the required reserve amount has been the same as that on deposit-taking institutions’ current accounts with the Central Bank. Currently it is 4%.
At a special meeting held on 4 June 2018, the Monetary Policy Committee approved new Rules on Minimum Reserve Requirements and determined the interest rate on deposits held in reserve accounts. The changes entail dividing the reserve requirement into two parts: an average maintenance level (as has been in place hitherto) and a fixed reserve requirement. The fixed reserve requirement obliges entities subject to minimum reserve requirements to hold a minimum amount in a separate reserve account with the Central Bank at all times. The fixed reserve requirement amounts to 1% of the reserve base and bears no interest. The reserve requirement with averaging is 1% of the reserve base and currently bears 4% interest, as it did before this change.
Concurrent with this change, the provision in the Rules on Minimum Reserve Requirements authorising entities subject to reserve requirements to act as intermediaries for a third party’s reserve requirements has been deleted from the Rules, owing to a lack of transparency associated with that provision. In addition, changes in wording were made where appropriate, although these changes do not otherwise affect the substance of the Rules.
These changes are not intended to affect the monetary stance. The objective of the changes is to reduce the cost to the Central Bank in holding large international reserves while the positive interest rate differential with abroad is as wide as it currently is, but without disturbing the monetary stance or the monetary policy transmission mechanism. The Monetary Policy Committee is of the opinion that the changes satisfy these requirements, as the marginal interest rate on the required reserves will remain the same as that on the banks’ current accounts with the Central Bank and the reserve requirement with averaging will remain in effect for half of the reserve amount. In his speech at the Bank’s Annual Meeting on 5 April 2018, the Governor signalled that changes of this type were forthcoming. The speech also contains further analysis of the cost borne by the Bank in maintaining large international reserves financed domestically and presented grounds for sharing that cost with other stakeholders. Overall, the impact of this measure on the banks’ income is relatively limited. All else being equal, the banks’ annual interest income could decline by 0.02% of their balance sheet.
The new Rules on Minimum Reserve Requirements will take effect at the beginning of the next reserve maintenance period, Thursday 21 June 2018.
The Rules on Minimum Reserve Requirements can be found here. (In Icelandic).
Further information can be obtained from Már Guðmundsson, Governor of the Central Bank of Iceland, at tel: +354 569 9600.
5 June 2018