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I.INTRODUCTION

The reserve requirement is one of the tools used by the BSP to manage liquidity in the economy. It is the proportion of deposits placed in banks that must be kept with the BSP as reserves.

The

Bangko Sentral ng Pilipinas

has decided

to

cut

the reserve

requirement ratio for banks by 3 percentage points in what officials said was part of an overall effort to rationalize the way liquidity in the economy was being managed.

With the reduction, the reserve will go down to 18 percent from the current 21 percent. The lower reserve requirement took effect last April 6,

2012.

The cut in the reserve requirement ratio comes with other measures were meant to rationalize the overall reserve requirement framework.

First,

the BSP

will

no longer allow

banks to

keep

a

portion

of

the

reserves in their own vaults, which means all reserves will be kept at the

central bank. Under the old system, 10 percent of deposits are with the BSP and 11 percent are kept by the individual banks.

Second, the BSP would no longer pay interest on the reserves. Under the old system, an interest of 4 percent a year is paid on 40 percent of the reserves kept by the BSP. An interest equivalent to 50 basis points below comparable government securities is paid on the reserves kept by the banks in their own vaults.

II.FACTS

RESERVE REQUIREMENT

Reserve requirements refer to the percentage of bank deposits and deposit substitute liabilities that banks must keep on hand or in deposits with the BSP and therefore may not lend. Changes in reserve requirements have a significant effect on money supply in the banking system, making them a powerful means of liquidity management.

Required reserves consist of two forms: regular or statutory reserves; and liquidity reserves. Deposits maintained by banks with the BSP up to 40 percent of the regular reserve requirement are paid interest at 4 percent per annum, while liquidity reserves are paid the rate on comparable government securities less half a percentage point. The use of liquidity reserves help to reduce bank intermediation costs since they are paid market-based interest rates. In March 2006, the Monetary Board began to require banks to keep liquidity reserves in the form of term deposits in the reserve deposit account (RDA) with the BSP instead of government securities bought directly from the BSP.

INTERNATIONAL RESERVE

Any

kind

of reserve funds that can be passed between the central

banks of different countries. International reserves are an acceptable form of payment between these banks. The reserves themselves can either be gold or else a specific currency, such as the dollar or euro.

International reserves are also used by countries to back liabilities such as any local currency that has been issued as well as bank deposits. Special drawing rights are another form of international reserves. It was

created by the International Monetary Fund to supplement the existing reserves of member countries.

KENESIAN THEORY OF ECONOMICS

Keynesian economics is an economic theory named after John Maynard Keynes, a British economist who lived from 1883 to 1946. He is most well-known for his simple explanation for the cause of the Great Depression. His economic theory was based on a circular flow of money, which refers to the idea that when spending increases in an economy, earnings also increase, which can lead to even more spending and earnings. Keynes' ideas spawned numerous interventionist economic policies during the Great Depression.

In Keynes' theory, one person's spending goes towards another person's earnings, and when that person spends his or her earnings, he or she is, in effect, supporting another person's earnings. This cycle continues on and helps support a normal, functioning economy. When the Great Depression hit, people's natural reaction was to hoard their money. Under Keynes' theory, this stopped the circular flow of money, keeping the economy at a standstill.

Keynes' solution to this poor economic state was to "prime the pump." He argued that the government should step in to increase spending, either by increasing the money supply or by actually buying things itself. During the Great Depression, however, this was not a popular solution. It is said, however, that the massive defense spending that United States president Franklin Delano Roosevelt initiated helped revive the U.S. economy.

III. ANALYSIS

The changes and the reserve cut were aimed at simplifying the reserve requirement regime and ensure adequate liquidity in support of economic growth. With the reduction in the reserve requirement ratio, the operational changes should not affect banks' lending and deposit rates or their service fees. The central bank will also stop paying interest on these funds set aside by lenders under the new rules. It will also exclude banks' vault cash and demand deposits of non-bank financial institutions with quasi-banking functions from eligible reserves. The central bank said it anticipated the operational reforms to the reserve requirement may have some impact on banks' intermediation costs, prompting the cut. The current reserve ratio of banks is broken down into 10% statutory and 11% liquidity. The central bank is paying 4% per annum on up to 40% of deposits maintained by banks as statutory reserves. Interest paid by the central bank on liquidity reserves are based on the rate of comparable government securities less half a percentage point.

IV.CONCLUSION

The new reserve requirement framework would have a neutral effect on the amount of liquidity in the economy. This is because there is a belief among regulators that banks do not religiously comply with the “liquidity reserve” rule, in that the money banks that should be kept as reserves in their own vaults are actually being used for operations, such as lending. Therefore, requiring banks to put all reserves to the BSP and lowering the reserve requirement should not lead to an increase or decrease in the overall liquidity in the economy. Also, inflation should also not be affected. The BSP said the overhaul of the reserve requirement is not meant to temper inflation nor to help accelerate growth in liquidity and growth of the economy. The move was just intended to rationalize and simplify the reserve requirement framework.

IV.RECOMMENDATION

A reduction in the reserve requirement results in higher amount of money that will circulate in the economy. A cut in the reserve requirement will allow banks to use idle liquidity for investment and increased lending, and earn more. Banks may freely use of their funds for other investment activities that could generate better yields. Because of the reduced reserve requirement increases the amount of loans that banks can make and increases the money supply.

REFERENCES

http://business.inquirer.net/43259/bank-reserve-requirement-cut-to-18

A reduction in the reserve requirement results in higher amount of money that will circulate inhttp://economics.about.com/od/monetary-policy/a/The-Federal-Reserve- System.htm http://www.bsp.gov.ph/monetary/targeting.asp http://business.inquirer.net/43259/bank-reserve-requirement-cut-to-18 http://www.wisegeek.org/what-is-keynesian-economics.htm http://www.investopedia.com/terms/i/international- reserves.asp#ixzz2NEuPA5fC Saint Louis College " id="pdf-obj-4-20" src="pdf-obj-4-20.jpg">

Saint Louis College

A reduction in the reserve requirement results in higher amount of money that will circulate inhttp://economics.about.com/od/monetary-policy/a/The-Federal-Reserve- System.htm http://www.bsp.gov.ph/monetary/targeting.asp http://business.inquirer.net/43259/bank-reserve-requirement-cut-to-18 http://www.wisegeek.org/what-is-keynesian-economics.htm http://www.investopedia.com/terms/i/international- reserves.asp#ixzz2NEuPA5fC Saint Louis College " id="pdf-obj-4-24" src="pdf-obj-4-24.jpg">

City of San Fernando, La Union

City of San Fernando, La Union

College of Commerce, Secretarial and Accountancy

REACTION

PAPER

SUBMITTED BY:

CORTEZ, JEANETTE G.

BSBA-3

SUBMITTED TO:

Mr. Nemesio P. Villamil

INSTRUCTOR

March 2013

REACTION

PAPER

SUBMITTED BY:

CORTEZ, JEANETTE G.

BSBA-3

SUBMITTED TO:

Mr. Nemesio P. Villamil

INSTRUCTOR

March 2013