Peru: Reserve Requirements, GFC

The GFC in Peru consisted of two relatively distinct phases. In the first phase, considerable capital inflows led the BCRP to raise reserve requirements as a countercyclical measure (Quispe and Rossini 2010). Then, the second phase (starting in September 2008) featured a liquidity freeze that caused the BCRP to lower reserve requirements to release liquidity to the banking system (Quispe and Rossini 2010). According to Quispe and Rossini, two BCRP officials:

During the first stage of the global financial crisis, the increases implemented in the reserve requirement rates in soles and US dollars allowed financial entities to accumulate liquid assets in both currencies in a context of important capital inflows. Given the severe constraints of international financial liquidity characterising the second stage of the global crisis (after the failure of Lehman Brothers), these liquid assets accumulated as reserve requirements were made immediately available in order to guarantee normal operations in the money market. (Quispe and Rossini 2010, 309)

Before and during the GFC, Peru maintained a largely dollarized economy. Fifty percent of credit in 2009 was held in US dollars. In an economy materially reliant on a foreign currency, there are serious consequences that accompany capital outflows, from credit contraction to weakened monetary policy tools. To ward off these possible issues, the BCRP had, for many years, kept reserve requirements at a much higher rate for foreign currency–denominated liabilities than sol-denominated liabilities (Quispe and Rossini 2010).

In 2007, capital flows to Peru increased by an “unprecedented” 10.1% of GDP. In February 2008, the BCRP raised reserve requirements on both domestic and foreign deposits to limit credit growth in the face of the sharp capital inflows. Also, however, the BCRP had in September 2007 removed reserve requirements on external loans with at least a two-year term. The intent was to tamp short-term external credit (Quispe and Rossini 2010).

After Lehman Brothers, a credit crunch led the BCRP to reverse the reserve requirement hikes to provide liquidity to the domestic banking sector (Quispe and Rossini 2010). The BCRP chose this tool in part because it had limited ability to use conventional monetary policy (Quispe and Rossini 2010). Quispe and Rossini (2010, 309) states that “the financial stress and higher risk aversion block the policy rate transmission channels, significantly reducing its signaling power.”

Quispe and Rossini (2010, 300–301) states that the BCRP had learned from the 1998 ruble crisis in Russia, which resulted in many banks failing, a credit crunch, currency depreciation, and capital outflows: “Using the experience gained from various external shocks, especially the Russian crisis of 1998, the BCRP designed an action plan to prevent a credit contraction during crisis events,” which included the reserve requirement policy.

Before the failure of Lehman Brothers in September 2008, the BCRP mainly focused on capital inflows risking financial excesses. While reserve requirements served as the “first line of defence,” the BCRP also conducted conventional monetary tightening, raising the policy rate by 200 basis points (bps) to 6.5%. The BCRP also purchased USD 8.4 billion in assets, at a quicker pace than usual, to prevent exchange rate volatility (Quispe and Rossini 2010).

After Lehman Brothers failed, the BCRP shifted its policy toward providing liquidity in domestic and foreign currencies (Quispe and Rossini 2010, 308). In addition to reducing reserve requirements, the BCRP introduced other liquidity measures. This included expanding the size and maturity of repo operations to one year, introducing a new swap facility for those counterparties that did not have the collateral to participate in repo operations, repurchasing its certificates of deposits (CDs) from banks, and issuing central certificates indexed to the US dollar (Céspedes, Chang, and Velasco 2012; Quispe and Rossini 2010). In total, the BCRP provided 9.6% of GDP through liquidity operations from September 2008 to March 2009; see Figure 3 (Quispe and Rossini 2010).

The BCRP relied on both the Organic Law, the foundational law establishing the structure of the BCRP, and Law No. 26702 for its authority to set reserve requirements. Law No. 26702 grants the BCRP the authority to establish minimum ordinary reserve requirements, as well as additional or marginal reserve requirements (Law No. 26702 2008, art. 164). This law also allows the BCRP to determine reserve periods, to identify which obligations are subject to reserves, and to impose fines on noncompliant institutions (Law No. 26702 2008, art. 164). Many of the BCRP’s circulars refer to Articles 53–55 of the Organic Law and Articles 161–166 of Law No. 26702 for legal authority (BCRP 2008q, 1).

The BCRP set an ordinary minimum reserve requirement and separate marginal reserve requirements for liabilities denominated in soles and foreign currencies. Required reserves were calculated on an averaged, monthly, and contemporaneous basis (Montoro and Moreno 2011).

The board of directors of the BCRP had the authority to change reserve requirement policy (Organic Law 1995, art. 19). The board comprised four members selected by the president of Peru, including the president of the BCRP, and three members selected by Congress (Organic Law 1995, art. 9).

There does not appear to have been additional external oversight on reserve requirement policy.

The BCRP announced the changes to the reserve requirement system through detailed circulars, as well as informational notes that provided a more general overview of the changes.

The circular on September 28, 2007—eliminating reserve requirements on loans extended by foreign institutions with terms longer than two years—stated that such changes would “[preserve] monetary stability” by “[complementing]” internal resources with those from abroad “for medium and long-term financing by local financial institutions” (BCRP 2007a).

In early 2008, the BCRP said that it raised minimum ordinary and marginal reserve requirements to sterilize “a recent significant inflow of foreign capital of a speculative nature” and strengthen liquidity levels (BCRP 2008e; BCRP 2008b).

As the BCRP began to lower reserve requirements, it characterized these changes as measures that would give entities greater flexibility in their liquidity management (BCRP 2008k; BCRP 2008m).

In a circular on November 30, 2008, the BCRP estimated that reserve requirement exemptions and reductions would release about PEN 200 million into the financial system (BCRP 2008o).

In a circular on December 31, 2008, the BCRP estimated that the minimum ordinary reserve requirement reduction in soles and foreign currencies would release about PEN 650 million into the financial system (BCRP 2008r). On March 12, 2009, the BCRP estimated that reductions in the minimum ordinary reserve requirement from 6.5% to 6.0% and the current account requirement from 1.5% to 1.0% would release about PEN 250 million into the financial system, thus promoting credit to the private sector (BCRP 2009c).

To satisfy the sol reserve requirement, financial institutions held vault cash at their institutions and in current accounts at the BCRP (BCRP 2008d). For non-sol reserves, financial institutions held foreign currency at their institutions and in dollar-denominated current accounts at the BCRP (BCRP 2008c). Marginal reserves had to be kept entirely at the BCRP (BCRP 2008d).

For both sol and non-sol liabilities eligible for reserve requirements, financial institutions had to hold at least 1% of liabilities subject to reserve requirements in the current account at the BCRP, starting in January 2008 (BCRP 2008a). This was then raised in the next month to 2% (BCRP 2008d). Later, while it was lowering reserve requirements, the BCRP also lowered the current account requirement to 1.5% in February 2009 and 1% in April 2009 (BCRP 2009b; BCRP 2009c).

In July 2008, the BCRP released a list of liabilities subject to reserve requirements, which included deposits and most other short-term obligations. It excluded subordinated debt, other bonds, and shareholders’ funds (BCRP 2008i). The BCRP issued occasional circulars adding new forms of debt to the list (BCRP 2007a; BCRP 2007b; BCRP 2008a; BCRP 2008c; BCRP 2008d; BCRP 2008g; BCRP 2008h; BCRP 2008i; BCRP 2008j).

External liabilities with at least a two-year term faced no reserve requirement from October 2007 until August 2008 (BCRP 2007a; BCRP 2007b; BCRP 2008i; BCRP 2008j).

The minimum ordinary reserve requirement applied to entities’ total eligible liabilities, calculated on an averaged, contemporaneous, monthly basis. In a contemporaneous framework, the period for calculating a bank’s requirement has the same end date as the period for calculating its reserves to meet that requirement. The lag in data collection creates an incentive for banks to set aside more reserves than necessary to make sure they don’t fall below their requirement (Montoro and Moreno 2011).

The BCRP applied its first marginal reserve requirement to the increase in banks’ eligible liabilities over their average level in December 2007 (BCRP 2008d). When it raised the margin reserve requirement in April 2008, it used April 2008 liability levels for the calculations (BCRP 2008t).

Reserve requirements in Peru applied to private financial institutions, including banking companies, financial companies, municipal savings and credit funds, municipal funds for popular credit, small and micro-enterprise development entities, savings and credit cooperatives, and rural savings and credit funds (Law No. 26702 2008, art. 16). They also applied to three state-owned financial entities: Banco de la Nación, Corporación Financiera de Desarrollo (COFIDE, a development bank), and Banco Agropecuario (an agricultural bank) (BCRP 2008d, 1).

According to BCRP officials, there were two main phases in the GFC. In the first phase (up to September 2008), the BCRP raised reserve requirements to prevent speculative capital inflows and tamp credit growth. After the collapse of Lehman Brothers, the BCRP reversed this path and provided liquidity to the banking system by gradually lowering reserve requirements to pre-crisis levels. BCRP officials specifically state that the actions during the first phase of the GFC “provided greater credibility for the second stage of policy intervention” (Quispe and Rossini 2010, 309–10).

Effective in October 2007, the BCRP eliminated reserve requirements on loans extended by foreign institutions with terms longer than two years—an “unconventional measure” (BCRP 2007a, 1; BCRP 2007b, 1; Quispe and Rossini 2010, 307). This policy attempted to fortify the domestic banking system by transforming the foreign currency funding from short term to longer term (Quispe and Rossini 2010). Quispe and Rossini states that banks’ longer-term funding expanded from 17% to 50% of external funding from the implementation of this measure to the end of December 2007 (2010). According to Céspedes, Chang, and Velasco, the portion of the banking system’s foreign debts that was long term rose from 22% in September 2007 to 58% a year later (2012). The BCRP reversed this policy starting in August 2008 by placing a 9% reserve requirement on these loans (BCRP 2008i; BCRP 2008j).

Ordinary Minimum Reserve Requirement

The BCRP applied a single ordinary minimum reserve requirement to both sol- and non-sol-denominated liabilities. Throughout 2008 until the collapse of Lehman Brothers, the BCRP steadily raised this rate from 6% to 9% (BCRP 2008d; BCRP 2008e; BCRP 2008g; BCRP 2008i). The final increase to reserve requirements during the GFC came on July 25, 2008, when the BCRP raised the ordinary minimum reserve requirement to 9% (BCRP 2008i).

The BCRP first reduced the ordinary minimum reserve requirement in December 2008 (effective January 2009), lowering it to 7.5% (BCRP 2008p). The BCRP estimated this would free up PEN 650 million in liquidity (BCRP 2008r). In February 2009, the BCRP further reduced the ordinary minimum reserve requirement to 6.5% (BCRP 2009a). The BCRP lowered the requirement in April 2009 to 6%, its pre-GFC level (BCRP 2009c).

Specific Domestic Currency Reserves

On February 1, 2008, the BCRP implemented a 15% marginal reserve requirement on sol-denominated liabilities (BCRP 2008d). This marginal reserve requirement applied to eligible liabilities in excess of their average level in December 2007 (BCRP 2008d). On March 25, the BCRP raised the marginal reserve requirements from 15% to 20% (BCRP 2008e,). The BCRP also implemented a 40% marginal reserve requirement on liabilities held by nonresident financial entities (BCRP 2008e). This measure attempted to stop speculative capital inflows (BCRP 2008t). The BCRP again raised marginal reserve requirements on April 28, 2008, to 25% (BCRP 2008g). This time, the BCRP used April 2008 liability levels for marginal reserve calculations (BCRP 2008t). The BCRP also raised the marginal reserve requirement on nonresident financial entities to 120% (BCRP 2008g).

In November 2008, the BCRP began to reduce reserve requirements. First, it eliminated the marginal reserve requirement for sol-denominated liabilities (BCRP 2008k). The BCRP estimated that this measure released PEN 967 million in liquidity (BCRP 2009d). Starting in December 2009, the BCRP exempted 33% of deposits held by financial institutions from reserve requirements, up to a limit of PEN 100 million. At the same time, the BCRP lowered the 120% reserve requirement on nonresident financial entities to 35% (BCRP 2008o). In December 2008 (effective January 2009), at the same time that it lowered the ordinary minimum reserve requirement, the BCRP lowered the maximum exemption of deposits to 16.5% (BCRP 2008p). See Figure 4 for a depiction of the path of ordinary minimum and marginal reserve requirements for sol-denominated liabilities.

For reserve requirements held in soles, the BCRP remunerated marginal reserves and excess reserves (reserves that exceeded the regulatory requirement) at the overnight deposit rate minus 100 bps, starting in February 2008 (BCRP 2008d; Montoro and Moreno 2011). This naturally went away for marginal reserves when the BCRP eliminated the marginal reserve requirement in soles in October 2008. Beginning in February 2008, the BCRP remunerated non-sol marginal and excess reserves at the London Interbank Offered Rate (LIBOR) minus 7/8 percentage point (BCRP 2008t). This changed in January 2009, when the BCRP began remunerating marginal reserves at 50% of the one-month LIBOR. The BCRP implemented this change because the previous rate of LIBOR minus 7/8 percentage point turned negative in the month of December (BCRP 2008s).

If banks did not provision enough reserves to meet reserve requirements, the BCRP applied a penalty rate of 1.5 times the active market interest rate in either soles or foreign currency, depending on the currency of the reserve deposit (BCRP 2008c; BCRP 2008d).

In the first phase of the GFC, the BCRP occasionally estimated the effective interest rate hike caused by raising reserve requirements. For example, when announcing the reserve requirement increases in April 2008, the BCRP estimated that these changes effectively increased the reference rate by 50 bps. The BCRP also stated that the changes in February 2008 resulted in an effective hike of 59 bps in the reference rate (BCRP 2008f).

Quispe and Rossini (2010, 309) state that, during crises, “the financial stress and higher risk aversion block the policy rate transmission channels, significantly reducing its signalling power.” They go on to note that, in such a context following the failure of Lehman Brothers, the BCRP had to shift from gradual monetary policy adjustments to more unconventional policies, including easing reserve requirements.

The BCRP did not lower the policy rate until February 2009, after the major changes to the reserve requirements had been made.

The BCRP announced changes to reserve requirements without providing guidance on how long these would last. By March 2009, the BCRP had returned reserve requirements to approximately pre-crisis levels (BCRP 2009c; Quispe and Rossini 2010).