Solidifying liquidity or cash buffer?

THE statutory reserve requirement (SRR) of Bank Negara has come under scrutiny, particularly after the central bank halved its reserve ratio to 1% effective May 16.

This raises pertinent questions: Is the SRR still relevant in today’s financial landscape? Could a reduced SRR discourage banks from holding excessive cash reserves under the guise of prudent lending practices?

These are critical issues to explore in light of recent policy changes.

Analyst Samuel Woo of MIDF Research says the 1% rate is “unnaturally low” and that the SRR cut strongly implies that the overnight policy rate (OPR) could also be reduced subsequently.

Malaysia’s SRR – the amount of cash lenders must keep in reserve – has been on an extended decline, dropping from 4% in 2011. However, this trend isn’t unique to Malaysia.

Thailand, which had a reserve ratio of 6% at the start of this millennium, now only requires 1% of deposits as a buffer.

The reserve ratio in China was 21.5% for large banks and 19.5% for smaller banks in 2010.

Since then, it has been significantly reduced, averaging 6.2% after the latest cut on May 7.

China also dropped the reserve ratio for auto financing and financial leasing firms to 0%, to support auto consumption and equipment increase investments.

Meanwhile, the United States’ overall reserve ratio has been 0% since March 2020.

More countries are easing the reserves requirement for banks to increase liquidity and prop up the debt-fuelled global economy.

The SRR is calculated as a percentage of banks’ “eligible liabilities” and is parked with Bank Negara under the statutory reserve account (SRA).

Eligible liabilities consist of ringgit-denominated deposits and non-deposit liabilities, net of interbank assets and placements with the central bank.

The SRR is designed to manage a significant build-up of liquidity and act as a buffer in the event of bank runs or mass cash withdrawals by customers.

For example, with the previous SRR of 2%, a bank holding RM100 in eligible liabilities would need to allocate RM2 to the SRA. The balance RM98 could be lent out.

With the SRR at 1% now, the SRA amount is also reduced to RM1.

This means that banks have RM99, or an extra RM1, to lend.

Higher liquidity in the banking system does not necessarily mean that banks will give more loans.

Banks in Malaysia are typically prudent with their lending in line with Bank Negara rules and this approach is expected to continue.

Businesses are also likely to be more cautious in taking up new loans amid the global economic uncertainties.

The reduced SRR simply prepares the domestic banking system for the possibility of greater volatility in global financial markets.

The SRR is only one of the tools at Bank Negara’s disposal for risk control.

As other risk control measures are used, the SRR’s importance has declined, says Nazmi Idrus, head of economics at CGS International (CGSI) Securities.

“I don’t rule out chances of the SRR dropping to zero but I also think that it is a tool best used in times of need.

“If there is no urgency for liquidity measures, it’s best for Bank Negara to hold off zerorising it,” Nazmi tells StarBiz 7.

Sunway University economics professor Dr Yeah Kim Leng believes that the SRR is no longer a primary instrument to manage banking liquidity and stability.

According to Yeah, the relevance and usefulness of SRR especially in advanced economies have given way to more flexible market-based tools that include open market operations, interest on reserves and quantitative easing.

“While emerging economies with less deep financial markets such Brazil, China and India still rely on SRR, most developed countries such as the United States, the United Kingdom, Canada and Australia have done away with it while the eurozone maintains the SRR at 1% but does not use it to actively manage banks’ liquidity.

“With other market-based monetary tools at Bank Negara’s disposal, the reduction of SRR to 1% does not affect its ability to maintain financial stability and banking efficiency given that the SRR is akin to a tax on banks,” he says.

As a result of the 100-basis-point (bps) reduction of the SRR, about RM19bil of liquidity will be released into the banking system.

Interestingly, many economists do not think that the domestic banking system needs more liquidity.

Socio-Economic Research Centre (SERC) executive director Lee Heng Guie says the credit market is not tight and there is ample liquidity.

“Of course, it doesn’t hurt to have more liquidity but banks will not necessarily lend just because the SRR has been cut,” says Lee.

The SRR cut, which many economists see as a precursor to a reduction in the benchmark OPR, was announced amid slower loan growth in Malaysia.

It is noteworthy that the banking system’s average loan rate slipped to 4.97% in March, down from 5% a month earlier and 5.37% in March 2024.

In the first three months of 2025, banking system liquidity, measured by bank deposits in the central bank, fell 18% year-on-year to RM139bil by end-March.

Over the same period, loan-to-deposit ratio edged up close to two percentage points to nearly 88%.

“Both indicators point to a downward trend, suggesting that the SSR cut to inject will help to shore up liquidity.

“It could also be a pre-emptive measure against volatile financial flows amid rising global fear and uncertainties brought by Trump’s tariff shocks and America-first policies,” according to Yeah.

Nazmi points out that banking deposit growth in Malaysia has been softening faster than the moderation in loan growth.

“This hints of potential liquidity tightening, so the SSR cut is not unexpected.”

Kenanga Research says in a note that banks have been increasingly selective in extending credit.

Therefore, the SRR cut likely reflects Bank Negara’s intention to ease funding cost pressure in the banking system.

More liquidity lowers the marginal cost of funds, enabling banks to lend more without needing to adjust the policy rate.

A source tells StarBiz 7 that Bank Negara decided to lower the SRR as it felt some banks are “hoarding” cash by not lending enough.

Over the long run, this would be negative to credit market liquidity.

However, MIDF Research believes that the lower SRR will be more positive for banks’ net interest margin than loan growth.

“While Bank Negara aims to boost economic activity by increasing loan growth, we believe it’s largely driven by demand. As a result, loan growth figures may not see a significant impact.

“There is a good chance that some of this excess cash will be put into Malaysian Government Securities bonds instead to shore up asset yields.”

CGSI’s Nazmi says the SRR cut will release RM19bil in “new lending”, although it is only 0.8% of outstanding loans.

“While this amount is arguably small, I think the SRR is still a liquidity tool.”

Yeah echoes the view, but adds that the overall stimulus on bank lending from the SRR cut will be helpful to individual banks, depending on their specific loan and deposit conditions.

Economist Geoffrey Williams explains that with more funds on hand, the cost of loans can be kept in check, preventing them from rising due to a lack of funds in the market.

“It helps to keep commercial interest rates lower, more stable and more in line with the OPR.”

With additional liquidity, will it be inflationary?

It is only possible if consumer loans increase, resulting in higher spending, according to Williams.

“This is if consumers take loans for consumption. If firms take loans for investment, then their output rises and their businesses improve on the supply side of the economy, so it is less inflationary.

“If the OPR was cut, this would reduce all interest rates and push more money into the economy across the board. This is more likely to cause inflation.”

OCBC senior Asean economist Lavanya Venkateswaran notes that SRR cuts have often been precursors to OPR cuts, or have at least accompanied cuts in the OPR.

In the last easing cycle, the SRR was cut by 50bps in November 2019, followed by a 25bps rate cut in the OPR in January 2020.

The OPR and SRR were reduced further at the March 2020 meeting.

Nazmi, however, thinks the past SRR cuts preceding OPR reductions could be coincidental. He also highlights that the SRR is a liquidity tool and not monetary.

Bank Negara has mentioned this repeatedly, so the decision to cut SRR is not an indication that the bank is dovish.

“So I don’t think it’s a choice between SRR or OPR, they aim for different objectives,” according to Nazmi.

Williams feels there is no need for an OPR cut for now as the country’s inflationary pressure is moderate, growth is strong, and banks are well-capitalised.

“Instead of cutting the OPR, Bank Negara is making more funds available but only if there is demand,” he adds.

Historically, SRR ratio cuts have been used to drive economic activity by boosting loan growth.

SRR ratio cuts tend to be pre-emptive, happening just before a weak gross domestic product growth year.

“The proposed SRR ratio of 1% is unnaturally low, and we expect it to increase when the growth outlook indicates convincing recovery,” says MIDF Research.

Hong Leong Investment Bank Research believes that the SRR move, while seemingly accommodative, is primarily aimed at preserving Malaysia’s financial market competitiveness amid regional easing trends.

“By using an SRR cut instead of an OPR reduction, Bank Negara strategically avoids direct pressure on the ringgit and the associated risk of imported inflation.

“It is positive for banks. Based on our calculations, the additional liquidity could boost bank net profits by 1% to 3%, providing a buffer against a potential rate cut.

“Our house view remains that a 25bps OPR cut is likely in the second half of 2025,” according to the research house.

A lower OPR will mean cheaper loans, while the reduced SRR will ensure adequate liquidity in the market.

Together, the OPR and SRR will potentially increase lending activities.