CBS in new moves to modernise financial system-● Banks no longer need have 35% deposits with govt |18 August 2009
He also said the minimum reserve requirement (MRR), which now stands at 12%, will be
“Until recently the banks were required to invest 65% of their local deposit base but this local asset ratio (LAR) had been reduced to 35%, and with effect from today the need to do this has been removed,” said Mr Laporte in an interview.
He called the move “a fundamental policy change in the context of the economic reform programme initiated in November 2008, which includes a move away from direct monetary policy instruments towards market-based, indirect instruments”.
“The LAR was instituted in 1986 and requires commercial banks to invest a percentage of their local deposit base in government securities. The LAR, which currently stands at 35%, is thus a direct and guaranteed source of financing for the government,” he said.
Mr Laporte, however, said the requirement can also have adverse effects such as making the money unavailable for private sector bank financing.
“Consistent with the objectives of the monetary policy reforms, which among other things aim at modernising the financial system, the Central Bank is of the view that the LAR is no longer useful or needed as a monetary instrument,” he said, adding that the bank now monitors commercial banks very closely and on a daily basis.
“The disciplined fiscal stance adopted by the Ministry of Finance recently has curtailed its financing needs from the banking system, while the adoption of numerous indirect monetary instruments by the Central Bank has made the LAR a redundant policy instrument,” he said.
“In the light of this, the Central Bank has taken a decision to abolish this instrument with effect from August 17, 2009.”
Mr Laporte also said the MRR requires banks to deposit a percentage of their deposit liabilities – both foreign currency and rupee – with the CBS, allowing it to control liquidity in the banking system.
But with the introduction of more market-oriented instruments as part of the macro-economic reforms, the role of the MRR as a policy tool has been significantly reduced,” he said, announcing the gradual reduction to 10% on October 1.
“The Central Bank will consider further reductions and eventual elimination of this instrument as and when appropriate,” he said.
He said the International Monetary Fund mission that was here last week was consulted over the decisions and it endorsed these moves.