Reserves, deposits and loans

Economics Malaysia Friday, March 9, 2012

Economics Malaysia

It’s one thing for a layman not to grasp the intricacies of macro-economics – but its quite another for analysts and economists to make basic mistakes. (Graphic by Dayang Norazhar/The Mole)

RM420 billion refers to international reserves, which are not “ringgit deposits” – what the hell do international reserves have to do with bank lending?

The level and change in reserves ONLY effects credit growth under a fixed exchange rate regime or a currency board, but ONLY if the central bank does unsterilised intervention and ONLY if banks respond to the higher liquidity conditions by chasing yield (i.e. lending more AND/OR buying higher yielding securities).

The link between international reserves and liquidity conditions in the banking sector doesn’t exist under a floating rate regime such as Malaysia operates today – central bank intervention under those circumstances is purely discretionary, hence changes in reserves signals absolutely nothing about future lending or banking sector liquidity.

Even under a fixed exchange rate regime, the influence is conditional and the causality runs the other way – higher reserves signals (i.e. is caused by) higher liquidity, not the other way around.