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Requirements and Incentives for Central Bank Deposits in Major English Speaking Countries.

In Money Supply on May 19, 2011 by CQCA

Why do some countries’ banks keep excess reserves? Much of the reason has to do with financial stability and the limited amout of options to invest such a large amount of money. There are also requirements and incentives for keeping reserves at the central bank.

The chart above shows the required reserve rate and interest paid on deposits at the central bank. The United Kingdom, Canada, Australia, and New Zealand do not have reserve requirements.

New Zealand pays the highest interest rate on deposits. In addition to not having a reserve requirement, Australia also does not pay any interest on deposits.

Banks are currently limited by what they can do with this money. Investing that in the stock market would be difficult and risky. There is currently no demand for mortgages or any traditional uses for bank credit. The only realistic market that could handle such a large movement of capital flow would be government debt.

In the above chart, the blue columns reflect the interest rate paid on deposits at the central bank. The red columns reflect the average one year treasury yield on local government debt.

Australia does not pay a deposit rate, and it also has the highest yield on treasury securities, therefore Australian banks have the most to lose by keeping their money at the central bank. In Canada and the United States, the central bank deposit rate is higher than the treasury yield, so they are actually making more money by keeping it on reserve at the central bank. I am not quite sure why U.S. and Canadian banks have responded so differently to essentially the same condition. I also do not know where Canadian banks have invested their money. It is possible that Canadian banks have purchased Canadian treasury securities with the expectation that yields will fall in the future, whereas U.S. banks are waiting for the yield on U.S. treasuries to increase in the future, and are therefore waiting.

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