Reserve requirements on foreign currency deposits and the money multipliers in African countries

This study examines the reserve requirements on foreign currency deposits (FCDs) in African countries by focusing on how multiple or different reserve requirements on domestic demand deposits and FCDs affect the money multipliers in these countries. In some African countries, FCDs represent a substantial portion of the total deposits in their commercial banks and not so much in others. After providing some historical background with respect to the trends in FCDs and reviewing the extant literature on the subject, this paper undertakes the theoretical analysis and computations of the money multipliers for 44 African countries based on the reserve requirement ratios set by these countries. The assertion is that the money multipliers vary depending on the magnitude or degree of the foreign currency to local currency deposit ratios. Therefore, in African countries where Central Banks require uniform or different reserve requirements on both local demand deposits and FCDs, we expect the computed money multipliers to show that the higher the holdings of foreign currencies and FCDs relative to their local currencies and demand deposits, the lower the size of the money multipliers. Even though many Central Banks consider reserve requirements a useful but rarely used monetary policy tool, multiple or different reserve requirements may complicate their ability to control liquidity due to uncertainty and unanticipated shifts in foreign currency holdings by households relative to their local currencies. The monetary authorities’ inability to control liquidity will make the money multiplier less stable and unpredictable in many African countries. In terms of policy implications, reserve requirements on foreign currency deposits can impose a hidden burden on banks and therefore make the cost of intermediating in foreign currencies prohibitive, which may lead to disintermediation and capital flights and thus complicate liquidity control.

Keywords: Reserve requirements, Foreign currency deposits, Local currency deposits, Money multiplier, Deposit ratio, Liquidity control, African countries.