Direct Control Of Bank Liquidity
When it comes to the discussion of the traditional weapon of monetary control by the governing body or agency, we observed that the ability of commercial banks to create credit depends not only on their reserves but they are holding. The possibility of shifting these assets to the central bank of Nigeria implies that it is not only the cash position that crucial but also the liquidity of the banking system.
It further implies that, to be effective, the traditional weapons have to be pursued vigorously in a way that renders these assets illiquid. In this way interest rates will rise, and the prices of government securities will fall to the level at which it becomes unprofitable for the banking system to increase its loans and advances by disposing of government securities. If, however, a Central Bank is prevented, for whatever reason, from pursuing such a vigorous monetary policy, it can take measures that strike directly at the liquidity of commercial banks. Such policies include supplementary reserve requirements, variable cash ratios and variable liquidity ratios.
The policies have one feature in common they are non market weapons (In essence they do not require the existence of a developed market for their effectiveness), and herein lies there attractiveness for developing country. Furthermore, they involve the freezing of certain bank assets to assets that might otherwise serve as a basic for additional loans and advances.
Supplementary Reserve Requirements
As the name suggests, a supplementary reserve requirement requires commercial banks to hold, over and above the legal minimum cash reserve, a specified percentage of their deposits in government securities. Its main aim is to influence bank lending by freezing a certain proportion of bank assets to assets that normally constitute the base on which banks erect their credit creating policies. In Nigeria, it has taken the form of special deposits and stabilization securities. At the discretion of the central bank, such deposits and securities may earn a rate of interest, but in Nigeria the rate is fixed at I percent below the Treasury Bill rate.
To what use, then can a policy of supplementary reserve requirement be put? As we have argued above;
- It can be used as an alternative to the traditional weapon of monetary control as not for fiscal control, particularly in environment where the money markets are underdeveloped and where commercial banks can always shift government securities to the central bank.
- Secondly, supplementary reserve requirements can be impose as an additional method of ensuring the liquidity of the banking systems.
- Thirdly, supplementary reserve requirements can be used to offset the impact of the inflow of capital from abroad. This is particularly necessary in countries whose banking scene is dominated by expatriate banks.
- Finally, the technique can be used as a supplementary to general monetary control method that should be adopted. Where it is based on government securities, it offers the attraction of more effective control of money supply than variations in cash reserves or the use of open market operations.
The effectiveness of supplementary reserve requirements depends on two factors, these factors are as follows;
- The availability of reserve eligible assets (in essence government obligation that qualities as reserve eligible assets and
- The proportion of banks shift-able assets that is immobilization under the scheme.
Since the aim of supplementary reserve requirements is to influence the lending capacity of the banking system by freezing some of the system’s assets, control (and availability) of the asset become crucial to the effectiveness of the policy.
Where for example, the reserve asset is a form of government security that is available on to the banking system for meeting reserve requirements, the central bank of Nigeria control over the cash reserve. But, on the other hand, if the reserve assets are just any form of government securities held by non bank financial institutions,
The central bank will not have a firm control over the volume of the reserve assets available to the banking system. The effectiveness of the supplementary reserve requirement also depends on the magnitude of bank held government securities, that are frozen under the arrangement and on the extent of the statutory power of the Central Bank of Nigeria to impose higher reserve requirements.
In order word, how large will the requirement have to be so as to constrain the lending power to this question, one can tentatively say that if the objective of the policy is to reduce, bank lending, the greater the amount of the bank held government securities that are immobilization or frozen under the arrangement, the more easily will that objective be achieved.