Issues in reserve requirement and monetary management in Nigeria

Abstract

Reserve requirement has been used over the years as a tool of monetary management. Accordingly, banks are required by law to hold a fraction of their deposit liabilities with the Central Bank as reserves. In recent times however, the use of reserve requirement has undergone modification, from drastic reductions to outright elimination. This is attributed to the perception that under rapidly changing structure and financial system innovations, reserve requirement is a weak tool of monetary management. This paper reviews these issues and examines the effects of required reserve on the balance sheet operations of Deposit Money Banks and its impact on the monetary aggregates in Nigeria. It revealed that reserve requirement has significant cost implications on both the Central Bank and the Deposit Money Banks, and that its potency as a tool of monetary management has been weakened as the targeted reserve does not reflect the total reserve level in the system. The paper recommends a drastic reduction of reserve requirement and fine-tuning to accommodate the interest of smaller banks.