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A note on reserve requirements and banks' liquidity

Joseph Bitar

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Abstract: Unlike past literature adopting the loanable funds view, we follow the financing model of bank intermediation in order to analyse the monetary mechanisms relating to reserve requirements and compute banks' margins on their lending and deposit activities. We show that, when remunerated at a rate below the money market interest rate, reserve requirements increase the spread between bank loans and deposits interest rates, without any impact on the level of interest rates. We review and analyse the uses of reserve requirements as a prudential tool and as a monetary policy instrument. We also analyse their use for capital flows management and for de‐dollarization in emerging economies. We argue that reserve requirements are a sub‐optimal and outdated policy tool, and we suggest imposing direct taxes on banks' deposits and loans interest payments, as a more efficient alternative to reserve requirements.

Date: 2020-12-28
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Published in International Journal of Finance and Economics, Wiley, 2020, ⟨10.1002/ijfe.2403⟩

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DOI: 10.1002/ijfe.2403

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