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QuestionWhat is the reserve requirement system? What are excess reserves?

Answer

Under the reserve requirement system, relevant financial institutions are required to hold a certain percentage (referred to as the reserve requirement ratio) of deposits and other liabilities in their accounts at the Bank. The minimum balance of current account or special reserve account that a financial institution is required to maintain as reserves at the Bank is referred to as the legal reserve requirement (or required reserves). The reserve requirement system was introduced as a monetary policy tool under the Act on Reserve Requirement System, enforced in 1957.

The Policy Board decides on the setting, changing, and abolishing of the reserve requirement ratios at Monetary Policy Meetings.

Reserve Requirement System as a Monetary Policy Tool

In the past, under the reserve requirement system, the operation to shift the reserve requirement ratios was an effective method to ease or tighten monetary conditions by influencing the lending attitude of financial institutions through the increase and decrease of their cost burden. However, currently, major countries, including Japan, where money markets are developed, do not use the reserve requirement system as a monetary easing or tightening measure. In Japan, the reserve requirement ratio has not been changed since October 1991.

From the 1990s, while the uncollateralized overnight call rate was the main operating target for the Bank's money market operations, encouraging financial institutions to maintain their daily current account balances at the Bank to meet the legal reserve requirement (or required reserves) became an increasingly important role of the reserve requirement system. This system made demand for current account deposits at the Bank -- namely, demand for funds in the money market -- generally stable and predictable, and based on this, the Bank encouraged the uncollateralized overnight call rate to remain at an appropriate level through its operations.

However, in the periods of the quantitative easing policy (2001-06) and Quantitative and Qualitative Monetary Easing (QQE; 2013-), holding excess reserves (an amount exceeding the legal reserve requirements) has become common for many financial institutions as a result of the ample provision of funds by the Bank, and it has become difficult for the reserve requirement system to be utilized as a measure to stabilize financial institutions' current account balances at the Bank. In this situation, under the Complementary Deposit Facility, the Bank applies interest rates to financial institutions' "excess reserves" -- thereby encouraging short-term interest rates to stay within a certain range through arbitrage transactions by financial institutions.

Financial Institutions Subject to the Reserve Requirement System

Financial institutions subject to the system include banks, shinkin banks (limited to those with deposit balances of more than 160 billion yen at the fiscal year-end), and The Norinchukin Bank.

Related Pages

For the current reserve requirement ratios, see Reserve Requirement Ratios. For financial institutions' reserve balances for each business day and amounts outstanding of the current account -- including the reserve balances -- at month-end, see Sources of Changes in Current Account Balances at the Bank of Japan and Market Operations and BOJ Current Account Balances by Sector, respectively.

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