Legal banking reserve in bolivia

Financial intermediation entities (multiple banks, savings and loan associations, development banks, savings and credit banks and even the Agricultural Bank) have the obligation to maintain in the Central Bank or any other place determined by the Monetary Board, a specific percentage of the amount of deposits captured by any modality.

This reserve is known as legal reserve and is applied to deposits in national and foreign currency.

In addition to being a support for the sustainability of the sector, that is, the solvency of banks, the legal reserve is a monetary instrument to restrict or expand the currency. If the legal reserve percentage is reduced, the money supply increases, and if it increases, then the money supply decreases.

This condition makes the legal reserve an ideal instrument for the application of monetary policies in certain circumstances.

Until last week, the legal reserve applied to multiple banks was 12.3% and was increased by the Central Bank to 14.3% as a measure to stop the rise in the dollar exchange rate. In the AAyP and savings and credit banks the reserve requirement went from 8.1% to 10.1%.

The following example shows an idea of how the legal reserve is applied: the profits of a commercial bank are obtained from the yield offered by the investment they make from the deposits they receive. That is, if a bank receives 100 pesos in deposits, it pays a passive rate of 3% per year to the depositor and lends those 100 pesos to the public, who charges an annual asset rate of 18%.

So the difference between the 3% you pay and the 18% you receive could be that bank's gross profit.

Now, the legal reserve is applied to the deposits received by the banks, and since it is now 14.3%, the example of the bank that receives deposits for 100 pesos, must keep 14.30 pesos of the legal reserve in the Central Bank. This means that you can only use 85.70 pesos to lend them later and get benefits with the interest rate.

Therefore, when the monetary authorities raise the legal reserve, financial institutions complain, because they see their profitability levels decrease or they choose, as they have just announced, to increase interest rates and maintain their profit levels.

The increase in the legal reserve also widens the gap between the passive rates (that the bank pays the depositors) and the active rate (that the beneficiaries of the loans pay the bank), since as they can only lend 85.7% of the deposits they receive, and must pay interest on 100% of those deposits, there is a need to offer a low passive rate and charge high active rates.

The application of the legal reserve is established in article 26, literal b) of the Law

Monetary and Financial 183-02. That literal expresses the following: “Financial intermediation entities will be subject to the legal reserve, understanding as such the obligation to maintain in the Central Bank or where determined by the Monetary Board, a percentage of the total funds raised from the public in any modality or instrument, be they in national or foreign currency.

The reserve requirement may be statutorily extended to other passive, contingent or service operations, if so considered by the Monetary Juan. Failure to comply with the reserve requirement will give rise to the corresponding sanction provided for in Article 67, literal c) of this law ”.

Generally, 90% of the legal reserve resources are deposited in the Central Bank and the remaining 10% is deposited in the financial entities themselves, based on the amounts that correspond to them.

Also called the cash ratio, the legal banking reserve is the percentage of a bank's money that must be kept in liquid reserves, and therefore, cannot be used to invest or make loans. The monetary authorities of each country will establish this minimum percentage of reserves that all financial institutions must comply with. However, there are financial institutions that tend to maintain a higher percentage than that indicated by the authorities.

Banks do not keep all the money deposited in them, this would not be profitable since the business of intermediaries is to take the money deposited and invest it where it pays the most, either by granting credits, investing in securities (stock market) or in debt (bonds).

A bank cannot invest everything it receives from deposits because it would run the risk of running out of liquidity and going bankrupt. To prevent this situation from occurring, the central bank requires them to keep a percentage of the deposits in their possession. The legal reserve is not of general application for all institutions, it depends on the value of their assets and the amounts deposited by savers in each institution, in such a way that the formula to determine it would be the following: Legal Reserve = assets of the banking system or reserves (ACSB) between deposits delivered by savers to the bank (D).