I.

INTRODUCTION

The reserve requirement is one of the tools used by the BSP to manage

liquidity in the economy. It is the proportion of deposits placed in banks that

must be kept with the BSP as reserves.

The Bangko Sentral ng Pilipinas has decided to cut the reserve

requirement ratio for banks by 3 percentage points in what officials said was

part of an overall effort to rationalize the way liquidity in the economy was

being managed.

With the reduction, the reserve will go down to 18 percent from the

current 21 percent. The lower reserve requirement took effect last April 6,

2012.

The cut in the reserve requirement ratio comes with other measures

were meant to rationalize the overall reserve requirement framework.

First, the BSP will no longer allow banks to keep a portion of the

reserves in their own vaults, which means all reserves will be kept at the

central bank. Under the old system, 10 percent of deposits are with the BSP

and 11 percent are kept by the individual banks.

Second, the BSP would no longer pay interest on the reserves. Under

the old system, an interest of 4 percent a year is paid on 40 percent of the

reserves kept by the BSP. An interest equivalent to 50 basis points below

comparable government securities is paid on the reserves kept by the banks

in their own vaults.

II.FACTS

RESERVE REQUIREMENT

Reserve requirements refer to the percentage of bank deposits and

deposit substitute liabilities that banks must keep on hand or in

deposits with the BSP and therefore may not lend. Changes in reserve

requirements have a significant effect on money supply in the banking

system, making them a powerful means of liquidity management.

Required reserves consist of two forms: regular or statutory reserves;

and liquidity reserves. Deposits maintained by banks with the BSP up

to 40 percent of the regular reserve requirement are paid interest at 4

percent per annum, while liquidity reserves are paid the rate on

comparable government securities less half a percentage point. The

use of liquidity reserves help to reduce bank intermediation costs since

they are paid market-based interest rates. In March 2006, the

Monetary Board began to require banks to keep liquidity reserves in

the form of term deposits in the reserve deposit account (RDA) with the

BSP instead of government securities bought directly from the BSP.

INTERNATIONAL RESERVE

Any kind of reserve funds that can be passed between the central

banks of different countries. International reserves are an acceptable

form of payment between these banks. The reserves themselves can

either be gold or else a specific currency, such as the dollar or euro.

International reserves are also used by countries to back liabilities such

as any local currency that has been issued as well as bank deposits.

Special drawing rights are another form of international reserves. It was

 created by the International Monetary Fund to supplement the existing

reserves of member countries.

KENESIAN THEORY OF ECONOMICS

Keynesian economics is an economic theory named after John Maynard

Keynes, a British economist who lived from 1883 to 1946. He is most

well-known for his simple explanation for the cause of the Great

Depression. His economic theory was based on a circular flow of

money, which refers to the idea that when spending increases in an

economy, earnings also increase, which can lead to even more

spending and earnings. Keynes' ideas spawned numerous

interventionist economic policies during the Great Depression.

In Keynes' theory, one person's spending goes towards another

person's earnings, and when that person spends his or her earnings, he

or she is, in effect, supporting another person's earnings. This cycle

continues on and helps support a normal, functioning economy. When

the Great Depression hit, people's natural reaction was to hoard their

money. Under Keynes' theory, this stopped the circular flow of money,

keeping the economy at a standstill.

Keynes' solution to this poor economic state was to "prime the pump."

He argued that the government should step in to increase spending,

either by increasing the money supply or by actually buying things

itself. During the Great Depression, however, this was not a popular

solution. It is said, however, that the massive defense spending that

United States president Franklin Delano Roosevelt initiated helped

revive the U.S. economy.

III. ANALYSIS
 The changes and the reserve cut were aimed at simplifying the reserve

requirement regime and ensure adequate liquidity in support of economic

growth. With the reduction in the reserve requirement ratio, the operational

changes should not affect banks' lending and deposit rates or their service

fees. The central bank will also stop paying interest on these funds set aside

by lenders under the new rules. It will also exclude banks' vault cash and

demand deposits of non-bank financial institutions with quasi-banking

functions from eligible reserves. The central bank said it anticipated the

operational reforms to the reserve requirement may have some impact on

banks' intermediation costs, prompting the cut. The current reserve ratio of

banks is broken down into 10% statutory and 11% liquidity. The central bank

is paying 4% per annum on up to 40% of deposits maintained by banks as

statutory reserves. Interest paid by the central bank on liquidity reserves are

based on the rate of comparable government securities less half a

percentage point.

IV.CONCLUSION

The new reserve requirement framework would have a neutral effect on the amount

of liquidity in the economy. This is because there is a belief among regulators that

banks do not religiously comply with the liquidity reserve rule, in that the money

banks that should be kept as reserves in their own vaults are actually being used for

operations, such as lending. Therefore, requiring banks to put all reserves to the

BSP and lowering the reserve requirement should not lead to an increase or

decrease in the overall liquidity in the economy. Also, inflation should also not be

affected. The BSP said the overhaul of the reserve requirement is not meant to

temper inflation nor to help accelerate growth in liquidity and growth of the

economy. The move was just intended to rationalize and simplify the reserve

requirement framework.

IV.RECOMMENDATION
A reduction in the reserve requirement results in higher amount of money

that will circulate in the economy. A cut in the reserve requirement will allow

banks to use idle liquidity for investment and increased lending, and earn

more. Banks may freely use of their funds for other investment activities that

could generate better yields. Because of the reduced reserve requirement

increases the amount of loans that banks can make and increases the money

supply.

REFERENCES

http://economics.about.com/od/monetary-policy/a/The-Federal-Reserve-

System.htm

http://www.bsp.gov.ph/monetary/targeting.asp

http://business.inquirer.net/43259/bank-reserve-requirement-cut-to-18

http://www.wisegeek.org/what-is-keynesian-economics.htm

http://www.investopedia.com/terms/i/international-

reserves.asp#ixzz2NEuPA5fC

Saint Louis College

 City of San Fernando, La Union
College of Commerce, Secretarial and Accountancy

REACTION

PAPER

SUBMITTED BY:

CORTEZ, JEANETTE G.
BSBA-3

SUBMITTED TO:
Mr. Nemesio P. Villamil
INSTRUCTOR
 March 2013

REACTION

PAPER

SUBMITTED BY:

CORTEZ, JEANETTE G.
BSBA-3

SUBMITTED TO:
Mr. Nemesio P. Villamil
INSTRUCTOR
March 2013