Has anyone thought before that some central banks are called Reserve Banks? Federal Reserve System of the US Reserve Bank of Australia Reserve Bank of New Zealand Reserve Bank of India South Africa Reserve Bank
This is because the word “reserve” refers to what banks have in cash reserves in their vaults or in the form of current deposits in the “reserve bank”, which we call the CBE, to meet emergency liquidity requirements.
A reserve to face liquidity risk.
And if part of this liquidity is withdrawn from the bank’s treasury, for example, by a number of depositors, the reserve will turn into another form of cash, which is the form of “banknotes outside the banking system” known as
Currency in circulation (CIC)
And as mentioned in a previous post, central banks – or reserve banks – are the only ones that pump and withdraw the issued cash, whatever its form: reserve or banknote.
So, the cash issued by the Central Bank is divided into: 1. Money inside bank vaults or deposited by banks with the Central Bank
2. Money with the rest of the community in a banknote picture
Reserve money = M0 = A + B A = Bank reserves B = Currency in circulation (CIC)
But the banks’ reserves – Bank reserves – are also divided into two parts: A) A minimum required to meet the requirements of the mandatory reserve (if any) and to ensure that there is sufficient liquidity for daily withdrawals and transfers.
B) Loanable surplus for companies, individuals, and the government
Bank reserves = required reserves + excess reserves
So, the money issued by the central bank can be redefined into three categories: A. Required reserves Minimum required reserves B. Excess reserves C. CIC Cash in circulation outside the banking sector
What the CBE did by raising the reserve ratio is reduce a part of B by transferring it to classification A without any cost to the Central Bank.
Finally, banks are exposed to two main types of shocks that lead to a severe shortage of liquidity in their vaults.
A fall in Bank reserves is usually triggered by 2 shocks First, a massive dollar exit from the country, as happened when foreigners exited treasury bills in January 2022.
When hot money exits in bulk, the banks use their liquidity reserves in the Egyptian pound to buy dollars from the CBE, which leads to severe pressure on the reserves they own.
Therefore, the Central Bank provided an exceptional mechanism for pumping liquidity to banks on January 10, 2022, called the Emergency Funding Facility.
Second, citizens rush to withdraw deposits from banks, which leads to a decrease in banks’ reserves and an increase in CIC.
This happened for a very short period in Egypt in 2012 when the CBE reduced the required reserve ratio from 14% (the ratio it has been since 2001) to 10% so that banks could provide cash to their customers and continue lending operations without pressure.