Czech Republic: Reserve Requirements, 1997

On April 11, 1997, in response to a domestic economic shock, the Czech National Bank (CNB) announced a lowering of the minimum reserve requirement (RR) ratio for banks from 11.5% to 9.5%, effective May 8 (IMF 1998). The RRR reduction reflected the first monetary policy instrument change for the year and represented a departure from the CNB’s tight monetary policy stance used to defend the koruna’s (CZK’s) fixed exchange rate regime (CNB 1998b; Horvath 2003). Following mounting political pressures for the CNB to relax monetary policy, the Czech government and the CNB made a compromise that allowed the CNB to ease RRs without undermining its commitment to protecting the currency. Under the terms of that compromise, the Ministry of Industry and Trade established an import deposit scheme in April that helped sterilize the additional bank liquidity released by the CNB’s RR decrease. The CNB also maintained high interest rates on its lending facilities (IMF 1998). In announcing the RR change, the CNB noted that the import deposit scheme allowed the CNB to relax RRs (CNB 1997b; Czech Ministry of Industry and Trade 1997).

The koruna continued to depreciate in May toward its lower bound amidst a major speculative attack (Hroldová 2009). On May 26, 1997, after repeated attempts to fend off speculative attacks, the CNB abandoned the koruna peg and switched to a managed float (CNB 1998b).

Beginning in 1998, the CNB transitioned to a new monetary policy regime based on inflation targeting (CNB 1998b; CNB 2000). In 1998 and 1999, the CNB continued to lower RRs in support of the CNB’s monetary easing policy, unlike in 1997. The CNB said that these changes served to harmonize monetary instruments with the ECB and promote the competitiveness of the Czech banking system (CNB 2000).

Leading up to the currency crisis in the first quarter of 1997, the CNB was reluctant to ease monetary policy because it was prioritizing the defense of the koruna’s peg to a basket of currencies (IMF 1998). Therefore, the CNB did not change any other monetary policy instruments when it reduced the RRR on May 8, 1997. However, the RR change came alongside the government’s economic correction measures announced in April 1997. These government measures included budgetary cuts and other economic correction measures to address the fiscal and current accounts deficits (CNB 1998b; Hroldová 2009).

Notable among these measures was the introduction of an import deposit scheme, which helped sterilize the additional liquidity from the RRR reduction (CNB 1998b; IMF 1998). The scheme required importers to deposit 20% of the value of their imports for a six-month period in koruna accounts at the Consolidation Bank, a state-owned bank that administered the scheme. It applied to 30% of all Czech imports. The proceeds from the scheme amounted to CZK 10.5 billion, half of which was then deposited with the CNB as additional koruna reserves, thus helping offset the liquidity released from the RRR reduction. The government retired the scheme in August 1997 (IMF 1998).

The CNB also increased loan loss provisioning requirements on July 1, 1997, in response to banks’ losses in securities markets. The new provisioning rules required banks^FThe CNB excluded banks “under conservatorship” from this requirement (CNB 1998b). to constantly create provisions for all securities whose market value fell below the purchase price; banks’ provisions against securities losses amounted to CZK 9.9 billion by the end of the year, double that of 1996 (CNB 1998b).

In 1998, the CNB increased provisions against nonperforming loans while at the same time lowering the RRR (CNB 1999; Hospodářské Noviny 1998).

Pursuant to Article 12 of the 1992 Act on Banks, all banks were required to maintain a specified ratio of reserves to their liabilities (Act on Banks 1992, 21/1992, article 12). Article 15 authorized the CNB to set such ratios and rules, including a mandatory requirement to reserve a certain portion of liquid assets to be deposited with the CNB (Act on Banks 1992, 21/1992, article 14-15). The CNB cited Article 15 as the legal basis for the RR change on May 8, 1997 (CNB 1997a).

Article 25 of the 1992 Act on the Czech National Bank (CNB Law) defined the parameters of RRs as one of the CNB’s monetary instruments. Accordingly, the CNB could require banks to deposit funds up to a maximum of 30% of total liabilities (net of liabilities to other banks) in non-interest bearing CNB accounts. Under special circumstances (for example, inflationary pressures) the CNB could impose RRs exceeding the 30% threshold; however, in such cases the CNB needed to pay interest, at the discount rate, on the excess requirements (Act on the Czech National Bank 1993, article 25).

If a bank had insufficient RRs, Article 26 of the CNB Law authorized the CNB to impose fines up to a maximum of three times the discount rate on the deficit funds (Act on the Czech National Bank 1993, article 26).

The CNB’s board of directors decided on any changes to RR policy, including the lowering of the RRR on May 8, 1997, in response to the crisis (CNB 1998b).

The CNB’s board of directors included seven members serving six-year terms: a governor, two vice-governors, and four chief executive directors. The board attended the weekly Monday meetings of the Open Market Committee. In these meetings, the CNB generated a forecast of the supply and demand for reserves for the remainder of the week. Included in the reserve demand forecast were the RR level as well as the surplus reserves in relation to short-term interbank interest rates (CNB 2000).

On April 11, 1997, the CNB announced a 200-bps RRR reduction that would take effect on May 8 (IMF 1998). In the weeks leading up to this change, the prime minister repeatedly criticized the CNB for keeping monetary policy too tight. The CNB implemented the RRR reduction as a compromise with the government following the government’s adoption of new economic policy changes to reduce expenditures and support economic growth (CNB 1998b; IMF 1998). The CNB’s press release on the RRR reduction said that the import deposit scheme provided for the ratio reduction (CNB 1997b). In the 1997 annual report, the CNB opined on the RRR decrease:

The CNB responded to the acceptance of the import deposit system aimed at limiting import growth by decreasing the minimum reserve requirements. This change was not very significant; however, by adopting this measure, the CNB signaled its willingness to gradually ease monetary restriction if the government more intensively engages itself in solving the economic problems. (CNB 1998b)

After the CNB announced the RRR decrease scheduled for May 8, 1997, domestic credit rates decreased slightly (CNB 1998b).

Banks held koruna-denominated cash accounts with the CNB, the balance of which constituted banks’ reserves. Banks used these accounts to settle interbank payments while ensuring the average level of these accounts (over the two-week maintenance period) did not fall below the RRR. If needed, banks could borrow overnight from the CNB or the interbank market to maintain sufficient RR funds (BIS 1997).

The CNB set the RRR as a percentage of a bank’s primary liabilities (Basna 2014; CNB 2000). Primary liabilities included government deposit accounts, client borrowings, issued bonds with maturities of up to five years, and foreign currency deposits, subtracted by any collateralized (by treasury bills and bonds) interbank borrowings of up to five years (CNB 1997c).

The CNB administered RRs by managing banks’ koruna-denominated accounts placed at the CNB. These reserve accounts were also used by banks for interbank settlement (BIS 1997). However, banks had to, at a minimum, ensure that the average balance of these accounts over the two-week maintenance period complied with the RRs (BIS 1997; CNB 1998a; CNB 2000). Banks computed their RRs as a percentage of their primary liabilities, which excluded interbank liabilities (Basna 2014; CNB 2000). The CNB gave the following formula for the calculation of the deposit base subject to RRs: government deposit accounts + client borrowings + issues of bonds with maturities up to five years + foreign currency deposits, netting out interbank borrowings collateralized by treasury bills and bonds (CNB 1997c).

Domestic banks and branches of foreign banks operating in the Czech Republic were required to have accounts at the CNB to meet RRs (BIS 1997; CNB 1997c). By the end of 1997, there were a total of 50 banks in the Czech Republic (CNB 1998b).

The CNB administered a separate, lower RRR for the Czech-Moravian Guarantee and Development Bank (CMZRB) and building societies (CNB 1997a). The CNB classifies CMZRB and building societies as “special banks” together with two other banks (Export Bank and Cm. Hypotecni Banka). As of the end of 1996, special banks accounted for 3.1% of assets of the banking system (BIS 1997).

Historically, the CNB changed RR policy infrequently (IMF 1998). In 1997, the CNB implemented only one RR change (CNB 1998b). In the following years, the CNB changed RRs once^FThe CNB’s board of directors announced two RR changes in 1998, the latter of which became effective later in January 1999 (CNB 1999). in 1998 and twice in 1999 (CNB 1999; CNB 2000).

During the 1997 crisis, the timing of the CNB’s one and only RR change was unique insofar as it occurred before any other changes in monetary policy instruments. In contrast with the RR change on May 8, the CNB waited until after the speculative attack on May 15 before changing rates for other instruments (CNB 1998b; Hroldová 2009). The CNB’s decision to lower the RRR followed the government’s economic policy corrections adopted on April 16, 1997. The government’s policy measures attempted to reduce expenditures and support economic growth and the transition to a market economy. By easing otherwise tight monetary policy, the CNB’s RRR reduction demonstrated support for the government’s economic changes (CNB 1998b).

From May 8, 1997, to October 7, 1999, the CNB lowered the RRR on primary liabilities from 11.5% to 2% through four separate changes (CNB 2001). See Figure 1.

Source: CNB 2001.

The changes in the RRR represented by Figure 1 exclude the separate RRR applied to building societies and the Czech-Moravian Guarantee and Development Bank (CMZRB). From 1995 until October 1999, the CNB maintained a lower 4% RRR for these specialized institutions, keeping this ratio unchanged during the 1997 currency crisis. On October 7, 1999, the same day the CNB lowered the RRR from 5% to 2% for all banks, the CNB also reduced the RR for building societies and the CMZRB to 2% (CNB 2001).

The CNB did not pay interest on the RRs until 2001 (CNB 2000).

Research has not determined any other restrictions on RRs.

The RRR reduction in May 1997 released CZK 20 billion in liquidity to banks, which was partially sterilized by the government’s new import deposit scheme. The scheme required importers of select goods to deposit 20% of their value for a six-month period (IMF 1998). The scheme resulted in an increase of CZK 10.5 billion in reserves, sterilizing about half of the RR change. From mid-1998, reductions in the RRR supported the CNB’s monetary easing policy. The dramatic lowering of the RRR in 1998 resulted in excess liquidity, which the CNB sterilized with repo transactions (CNB 1999).

When the CNB introduced the first reduction in the RRR on May 8, 1997, it did not provide an end date to the relaxation. Within weeks of the change, speculative attacks forced the CNB to abandon the exchange rate peg, ushering in a new era of monetary policy. After abandoning the peg on May 26, the CNB switched to a managed float and an inflation-targeting regime (CNB 1998b). The change in monetary regime also accompanied a gradual process of harmonizing the CNB’s policy instruments with those of the ECB. By October 7, 1999, after three more RRR reductions, the CNB eventually lowered the RRR to 2%, matching the requirements of the Eurosystem (CNB 2000).