Banks’ compulsory ratio raised to curb inflation

The State Bank of Vietnam (SBV) has made its first move in its plan to control inflation, expected to be very high this year, by requiring a higher compulsory reserve ratio for deposits.

Inflation reached 12.63% by the end of 2007; this was partly attributed to the poor monetary policy of the central bank. Now though, it seems the central bank has learned from its mistake: immediately in 2008, it decided to tighten credit by increasing the compulsory reserve ratio.

The compulsory reserve ratios, according to decision No 187 dated January 16, will increase by 1% and be applied to all kinds of deposits.

The VND demand deposit and less-than-12-month term deposits will have a compulsory reserve ratio of 11% instead of 10%, while the ratio for more-than-12-month term deposits will be 5% instead of 4%. The same compulsory reserve ratios will also be applied for foreign currency deposits.

The decision does not become effective immediately, but will become valid in February 2008, so that commercial banks can have more time to prepare. Meanwhile, the ratio increases will not be applied to credit institutions operating in rural areas (agriculture bank, rural joint stock banks, the central people’s credit fund and cooperation banks) so as to support economic development of rural areas.

An SBV official said the compulsory reserve ratio increases are actually quite gentle when compared to the increases in June 2007, when the central bank unexpectedly increase ratios into double digits (for example, the ratio for VND deposits of less than 12 months rose from 5% to 10%).

It seems that the central bank has decided to change tactics; it is trying to tighten credit step by step instead of suddenly turning off the ‘capital tap’, in order to avoid abrupt market shocks.

The official also said that the central bank cannot raise the compulsory reserve ratio too sharply right before Tet, which is always considered the most ‘sensitive’ moment of the year. In general, commercial banks need more capital in the months before Tet to fund their clients’ business deals, and the sharp increases in the compulsory reserve ratio will force banks to pay higher capital mobilization costs.

Deputy Director of a joint stock bank said the demand for capital is increasing, which is why banks have to offer higher interest rates for deposits.

“The 1% compulsory reserve ratio increase means that our capital mobilization cost is 1% higher,” he said.

However, he acknowledged that with the slight increase of 1%, commercial banks ‘will still be able to manage’. Besides, he said, this is a necessary move to curb inflation.

Leader of a state owned bank estimates that the decision will help the central bank withdraw some VND3tril ($187.5mil) from circulation.

The official believes that this is just the first move by the central bank in its strategy to control inflation, which may be followed by future, higher compulsory reserve ratios.

“The central bank is striving to gradually withdraw money from circulation, stabilize their monetary policy and curb inflation,” he said.

The 1% increase of the compulsory reserve ratio is just the first step the central bank needs to take in order to slow down inflation. It remains unclear how many times the compulsory reserve ratio will increase and when the central bank will stop. The State Bank will make those decisions after considering the performance of the monetary market.

Of course, commercial banks do not want these increases, because they make their capital mobilization cost higher. However, “if the compulsory reserve ratios are raised step by step, we will be okay,” a bank’s Director said. (Securities Investment Newspaper)