Statutory Reserve ratios limiting capital creation, economic growth

The Reserve Bank of Zimbabwe’s decision to maintain high statutory reserve ratios on call and demand deposits has sparked heated debate among economists and industry experts, with concerns mounting over its potential negative impact on capital creation and economic growth.

The monetary policies of central banks, particularly the regulation of statutory reserve ratios, play a crucial role in the functioning of a country’s banking system and economy and the decision to maintain high statutory reserves on call and demand deposits has stirred debate on its impact on capital creation and economic growth.

While the policy has its merits in terms of inflation control, many analysts argue that it is restraining economic growth by locking up capital that could otherwise be invested in productive sectors.

In his 2024 Mid-Year Monetary Policy Review Statement, Reserve Bank of Zimbabwe (RBZ) Governor Dr John Mushayavanhu reaffirmed the central bank’s stance, maintaining statutory reserves at 15 percent for call deposits and 20 percent for demand deposits.

These reserves are essentially a portion of the deposits that commercial banks must hold at the central bank and cannot lend out. While this policy is designed to control inflation, it also has a considerable downside. FBC Securities, a leading securities firm, in its analysis of the Monetary Policy Review, stated,

“The move to maintain high statutory reserves has left capital locked and idle, thereby not contributing to the growth of the economy.”

This view is shared by many within the financial sector who argue that such reserves limit the liquidity available to banks for lending, which directly stifles investment and economic growth.

Through locking in large portions of deposits as reserves, banks are left with fewer funds to extend credit to businesses and consumers, thereby reducing the potential for asset creation and investment in productive sectors.

Raymond Madziva, a prominent banker, emphasised the liquidity challenges faced by banks due to high statutory reserves.

“Banks are the lifeblood of the economy. They channel funds from savers to borrowers, enabling investment and consumption. However, when a significant portion of these funds is tied up in reserves, the ability to lend is severely constrained, leading to a slowdown in capital creation,” he said.

According to Madziva, banks are left with limited capacity to finance critical sectors such as manufacturing, agriculture, and infrastructure development, all of which are pivotal for economic growth.

The impact of high reserve requirements extends beyond just the banking sector as industrialist Dr Nxaba Ndiweni weighed in, highlighting how these policies are constraining industries.

“For manufacturing and industrial firms, access to affordable credit is essential for expansion, retooling, and upgrading technology. High statutory reserves limit the pool of funds available for lending, pushing up the cost of borrowing and discouraging investment in critical industrial sectors,” he explained.

Dr Ndiweni pointed out that while inflation control is necessary, policies that excessively restrict capital flow could ultimately hurt the very sectors that need financial support to drive economic growth.

Indeed, FBC Securities noted that “High reserve requirements have also been worsening liquidity conditions in the economy.”

The reduced liquidity not only affects banks’ lending capacities but also makes it difficult for businesses to access working capital. This, in turn, has a ripple effect on employment, production capacity, and overall economic activity.

As industries struggle to access capital, they may cut back on operations, which could lead to a rise in unemployment and a reduction in output, further stifling economic growth. Economist Gladys Shumbambiri-Mutsopotsi reinforced this sentiment, stating that high statutory reserves are a double-edged sword.

“On one hand, they provide a safety net by ensuring that banks have enough reserves to meet withdrawals during periods of financial uncertainty. On the other hand, in an economy that is already starved of investment capital, the decision to maintain such high reserves can be detrimental to long-term growth prospects,” she said.

Shumbambiri-Mutsopotsi added that while inflation control is important, it should not come at the expense of economic expansion and job creation.

There is also an argument to be made about the timing and context of such monetary policies as the economy is currently grappling with a host of challenges, including foreign currency shortages, energy crises, and declining industrial productivity.

In this context, many argue that the central bank’s focus should be on stimulating growth rather than solely controlling inflation.

Dr Ndiweni echoed this sentiment, pointing out that Zimbabwe is at a stage where economic revitalisation should take precedence.

“We need to be encouraging capital investment, not restricting it. High statutory reserves are suitable during periods of economic stability, but in times of economic distress, such as now, they may be doing more harm than good,” he noted.

However, it is important to acknowledge that statutory reserves do have their benefits and FBC Securities conceded that, “High statutory reserves provide a safety net for economies, especially during financial uncertainty.”

Through requiring banks to hold a portion of their deposits as reserves, the central bank ensures that banks have a buffer in case of unexpected withdrawals or financial shocks.

This is particularly important in economies where banking systems may be vulnerable to external shocks or financial instability. Yet, the Securities firm also acknowledged that this safety net comes at a cost, saying, “It can limit lending and economic growth.”

While the high statutory reserve ratios serve an important role in controlling inflation and maintaining financial stability, they are also limiting the capital available for lending, investment, and overall economic growth.

With liquidity conditions already tight, the reserve requirements may be exacerbating the challenges faced by businesses and industries that are in desperate need of capital.

As the country looks to revive its economy, a more balanced approach that considers both inflation control and growth stimulation may be necessary.

The RBZ should consider adjusting statutory reserve ratios in a way that allows for more capital creation, investment, and ultimately, economic expansion.-ebsinessweekl