The Central Bank yesterday in its monthly report on the rate of inflation and the repo rate stated that liquidity in the domestic financial system has remained very high and that commercial bank balances at the Central Bank in excess of the required levels averaged $5 billion over the first three weeks of February. As part of its exercise of monetary policy-which is the policies that Central Banks use to control the cost of money-T&T's commercial banks are required to hold a certain percentage of their deposits and other prescribed liabilities in a Central Bank account at zero per cent interest rate. The percentage currently stands at 17 per cent and it is referred to as the primary reserve requirement.
Along with the primary reserve requirement, the Central Bank has in place a secondary reserve requirement through which commercial banks are requested to hold two per cent of their prescribed liabilities in a secondary reserve, in an interest-bearing account. In addition to the primary and secondary reserves requirement, and because of the extreme liquidity situation, the Central Bank has requested that commercial banks place another percentage of their deposits in a special liquidity facility for an agreed timeframe. This adds another five per cent of the bank deposits that are being held at the Central Bank at this time.
In all, therefore, about 24 per cent of the deposits that commercial banks take in are sitting at the Central Bank earning little or nothing. And, on top of this, the commercial banks still have $5 billion in excess liquidity at the Central Bank.
If it is assumed that the T&T commercial banks hold deposit liabilities of $75 billion, 24 per cent or $18 billion is being held at the Central Bank in the primary, secondary and special deposit facilities and an additional $5 billion is being held above and beyond these reserve accounts. This means that for every $1 the country's commercial banks take in as prescribed deposits, they are required to deposit 24 cents at the Central Bank. It means, in effect, that the deposit base of the banks, which they can use to generate loans, is 76 cents on the dollar. This is partly responsible for the wide margins between deposit rates and loan rates in T&T. If the various reserve requirements were reduced, local commercial banks would be required to hold less money at the Central Bank and they would be forced to lower the cost of borrowing.
Lower loan rates would be attractive for people looking to buy houses, finance the purchase of new cars or furniture or their "summer vacation." Lower loan rates may also encourage some of our businessmen to take another look at new projects and it would therefore stimulate new investment. Given the fact that the local economy is currently at a standstill, some stimulation at this time may seem like the appropriate policy response. From past experience, central bankers know that when commercial banks start to advertise loan sales and lower the cost of borrowing significantly, it is almost always at the cost of prudential oversight. Additionally, a reduction in the cost of money will lead to a spending spree in T&T and because much of what Trinidadians buy is imported, lower lending rates are likely to have a negative impact on the country's foreign reserves and on the stability of the all-important exchange rate. Similar economic policies have led to financial disaster in Greece, Ireland and Iceland. Given the perils associated with lowering the cost of lending through a reduction in the reserve requirement, this would not be an appropriate policy response. The only way out of the liquidity conundrum would be for there to be an increase in the investment appetite of the local private sector.