SA Reserve Bank Amendment Bill: briefing

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Finance Standing Committee

29 August 2000
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FINANCE PORTFOLIO COMMITTEE
30 August 2000
SOUTH AFRICAN RESERVE BANK AMENDMENT BILL: BRIEFING

Documents handed out:
Presentation by Deputy Governor. Framework of address based on "
Minimum Reserve Requirements" by H F Nel
Banking Council's submission

SUMMARY
The Bill would amend the South African Reserve Bank Act to allow the Governor of the Reserve Bank to set a percentage of vault cash which banks may deduct from their reserve requirements. Presently, the Act allows banks to deduct the full amount of this vault cash. The Reserve Bank maintains that empowering the Governor to change this percentage (from what is presently effectively one hundred percent) will allow the Reserve Bank more flexibility to exercise better and more precise control over monetary policy.

MINUTES
Briefing on South African Reserve Bank Amendment Bill
James Cross, Deputy Governor of the South African Reserve Bank, explained that banks originally began entrusting money to central banks for safety and to protect their liquidity, later as a means of buying government bonds, and finally as a means of having funds at the location where settlements were taking place among different banks. Eventually, the government had introduced a reserve requirement. Mr Cross indicated that until 1993, the reserve requirement had been in the Banks Act, and that since 1993, it was in the South African Reserve Bank Act, meaning that it was no longer primarily a prudential measure but was recognised as a monetary policy instrument.

During the 1980s, the reserve requirement had been lowered on a number of occasions. During the 1990s, the minimum reserve requirement was changed from a fixed percentage of short-term liabilities to a fixed percentage of total liabilities. The current requirement is 2,5% of total liabilities, with the central bank paying no interest on this amount. Since 1998, there has been a repost system with these funds, whereby they are used on a daily basis and the banks must keep an average balance over a period of time.

Mr Cross indicated that last year's financial stability assessment by the World Bank and International Monetary Fund (IMF) was one consideration in the proposed amendment. Under most minimum reserve systems, vault cash cannot be deducted at all, as allowing this deduction is unfair to smaller banks. He stated that although some suggest that a reserve requirement is an implicit tax on banks, the IMF has analysed it and determined it to be a very low implicit tax. For the sake of maximum flexibility, the Reserve Bank seeks enabling legislation to allow it to set the percentage of vault cash that may be a deduction. It might then be able to choose to lower it over time for the benefit of the whole system.

The Chair asked Mr Cross to explain the repost system for new Committee members who might not be familiar with it. Mr Cross explained how the banks are dependent on their reserves and bring government securities to the Reserve Bank and borrow back in order to have funds for their reserves and the repost system.

Mr Cross added that over time, international experience shows that developing countries often have a much higher reserve requirement. He stated that banks have privileges that others do not and that it is reasonable that they maintain this reserve requirement. He later described being a bank as entailing a social responsibility since it was almost tantamount to having a club membership.

The Chair asked if greater reserve requirements are needed in order to meet crisis situations and whether there had been any kind of crisis the previous year.

Mr Cross answered both questions in the affirmative and noted that there had to be much rerouting of deposits around the Y2K situation. He outlined the advantages and disadvantages of having a reserve requirement at all. The advantages were: ability to meet financial crises; facilitating the central bank's role as supplier of currency; providing funds for the South African Reserve Bank. He stated that reserve requirements were imperative in South Africa. He stated that banks are different from other financial institutions, so this is not an unfair tax on them.

Mr Cross made some international comparisons. He stated that the paying of interest on reserve requirements varies from country to country. Even among G7 countries, the approach is not uniform. Canada is the only G7 country without any reserve requirement. The other G7 countries each have their own system with respect to the level of the requirement and the payment or non-payment of interest. He added information as to which G7 countries (aside from Canada to which the question is not applicable) pay interest on reserves (Germany, Italy) and which do not (United States, United Kingdom, France, Japan, Russia). Other countries that pay interest include: Chile, Israel, and Portugal. Those that do not pay interest include: Australia, Argentina, Brazil, Singapore, and Switzerland.

Discussion
There was a question about the introduction of the Bill by the Finance Department. Adv de Jager, Head of Legal Services and General Counsel of the South African Reserve Bank, noted that the state law advisors had effected some technical amendments to the Bill and this altered version was distributed to the Committee. The Chair asked Adv de Jager to take the Committee through the text of the altered Bill. Adv de Jager briefly explained that the existing Act allows the Governor to provide in the Gazette for a percentage of total liabilities as a reserve requirement to be kept in cash accounts at the South African Reserve Bank and that banks may deduct from this their vault cash. He stated that the Bill makes a further dispensation to allow the Governor to determine as well the percentage of vault cash that can be deducted. He stated that a new introduction in the altered Bill simply makes clearer the percentages to which reference is made.

Mr Andrew (DP) asked why it was fairer to different sizes of banks to refuse to allow the deduction. He asked why large banks would have any larger percentage as vault cash and, if they did, whether this was not simply a fact of the market.

Mr Cross answered that the exclusion of vault cash was introduced in 1985 when banks were more responsible for the distribution of cash but that the central bank now handles wholesale cash. He stated that issues of reserve requirements are part of monetary policy. He noted that the inclusion of vault cash makes the whole matter much less transparent and that if the central bank wants to drain cash from the system, it wants to be able to do so on a uniform basis.

Mr Andrew (DP) joked that he could not understand all that Mr Cross had said even if he had said it all well. He went on to ask if there was an intention to move away from the 100% deduction in the near future. Mr Cross answered that he could not speak for the Governor nor for the Reserve Bank. He stated that they needed flexibility to adjust the repost system and to move to international best practice. He stated that continuing to allow banks always to deduct all vault cash had the potential to interfere with monetary policy.

Prof Turok (ANC) asked if the Reserve Bank was addressing the prudence issue and the amount of cash in the system at the same time. Mr Cross stated that the prudence analysis of reserve requirements preceded the shift of these requirements to the Reserve Bank Act. With that shift, the government recognised that reserve requirements were a tool of monetary policy.

Prof Turok (ANC) also asked what was thought of the IMF's investigation. Mr Cross stated that the assessments had been in addition to the Article 4 consultations in order to test systems against international codes and standards and that the Reserve Bank had been very happy with the results of that assessment.

Mr Ramgobin (ANC) asked what percentage of non-interest-bearing reserves is allowed to be repurchased and if the central bank re-lends these with interest. Mr Cross replied that the full amount is available. He did not appear to answer the second aspect of the question.

The Chair commented that part of the reason for reserve requirements seemed to be to release additional funds in times of stress but that if vault cash counted against these, it seemed to weaken the Reserve Bank's powers.

Prof Turok (ANC) commented that it was not clear whether the actual motivation of the amendment was to make the central bank more powerful or simply to get rid of the vault cash deduction and thereby increase reserves. Mr Cross stated that it would give the bank options to do the latter.

The Chair asked what mechanisms would exist to provide certainty for banks in the wake of the new environment in which the central bank would have additional powers. Mr Cross replied that the banks are in an environment of some uncertainty even now and that the central bank always carefully considers their needs.

The Chair referred to the need to consult with banks and asked if changes in the percentage deduction would not be more of a structural change rather than a fine-tuning. Mr Cross answered that other instruments existed for fine-tuning and that this would be more for structural shifts in policy.

The Chair noted that a crisis might require some fine-tuning. Mr Cross stated that it is important to differentiate a crisis and a desire to change a policy.

Dr Woods (IFP) asked about international best practice on this issue. Mr Cross did not seem to answer directly but noted that South Africa was still far from the UK's system and that the aims of monetary policy could not be achieved in the longer term without flexibility.

The Chair asked if it was fair to the large banks to make this change since there had been suggestions that it would have a differential impact on institutions of different sizes. Mr Cross answered that matters are presently stacked in favour of the larger banks. He acknowledged that a change in the system would not be effected in just one day but would be a structural change over time. However under the present system, large banks may simply cease to have any reserve requirement if they keep enough vault cash.

Mr Andrew (DP) asked if the change will make it less desirable for banks to hold cash than at present and noted that the banks providing cash seems to be part of a broader service that they perform. Mr Cross stated that the suggested consequence was not necessarily a natural consequence but that it would be discussed in the course of any discussions on changing the system. For now, he reiterated that the Reserve Bank was seeking enabling legislation.

Dr Rabie (NNP) asked why it is difficult to quantify vault cash. Mr Cross answered that there is always an exact figure but that it is not known until the next day, so there is a short-term information problem.

The Chair asked how soon the Reserve Bank might introduce a percentage or if it was not on the immediate horizon. Mr Cross replied that there needed to be a policy discussion at the bank on a number of issues and that he could not speak for the Governor. He also noted that there would likely be compensating changes in other parameters.
The Chair thanked the presenter and indicated that the original date for hearings and formal consideration would be delayed because the Minister was unavailable on the relevant day.

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