CRR and SLR as macroprudential tools: Some Historical Lessons

Nice paper by Eric Monnet (Banque de France) and Miklos Vari (IMF):

Liquidity regulations similar the current Basel III Liquidity Coverage Ratio (LCR) have been used from the 1930s to the 1980s in many countries as monetary policy tools. They took the form of required deposits at the central bank (“cash reserve requirements”) or minimum holdings of liquid securities (“securities reserve requirements”). As with the LCR, these two types of liquidity requirements (cash and securities) were computed as a percentage of short-term deposits.

India obviously had Cash Reserve Ratio since 1935 and SLR since 1949 and continues to have both these ratios.

Our paper presents three contributions.

First, based on detailed readings of historical central banks’ reports and documents, we describe how and why liquidity ratios were used in many
countries (especially Europe) from the 1930s to the 1980s , following the American experience. By emphasizing the distinction between “securities-reserve requirements” and “cash-reserve requirements,” we provide details on central bank practices whose history is largely unknown, and shed light on the dual nature of liquidity ratios as prudential and monetary policy tools.

Second, we show how “securities reserve requirements” were at the crossroad of monetary policy and sovereign debt management. It explains why they were phased out by central banks in the 1980s, as they had been associated with the so-called “financial repression” era (Reinhart and Sbrancia (2015)). Securities-reserve requirements were typically used in a period when banks held a large share of government bonds, and they reinforced such phenomenon. Central banks increased liquidity ratios during times of restrictive monetary policy in order to prevent banks from selling government securities, which were the main type of assets eligible to fulfill the requirement. As such, banks were discouraged to shift their assets from government securities to corporate loans.

Third, we build a theoretical model, and show that the mechanisms previously described can be rationalized with a simple model of the interbank market. By this, our paper introduces a new mechanism in the current literature on liquidity regulation and sheds new light on the history of monetary policy.

Hmm. Even without CRR and SLR, RBI has been using macropru policies much before they became buzzword. See these 2010 speeches by Shyamala Gopinath of RBI and James Caruna of BIS. 

SLR in particular has long been seen as a villain and something which led to financial repression. Several RBI Governors and other officials have written to either remove SLR or bring it to zero. Similar story was played in West too but much earlier than RBI.

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