## Understanding in 3 Minutes: What Exactly is the Reserve Requirement Ratio Cut? - Huxiu.com#

#Omnivore

Good news is here!

On January 24, 2024, the governor of the central bank announced that the central bank will cut the reserve requirement ratio by 0.5% on February 5.

Based on China's deposit scale of approximately 200 trillion yuan, a 0.5% reserve requirement ratio cut can release 1 trillion yuan of long-term funds.

After the announcement of the reserve requirement ratio cut, the market responded accordingly.

Why does the reserve requirement ratio cut have this effect? First, we need to understand what the reserve requirement ratio is!

The so-called reserve requirement ratio refers to the reduction of the deposit reserve ratio, which is one of the "three traditional magic weapons" of the central bank's monetary policy.

To explain the reserve requirement ratio clearly, let's start with a little story:

The neighbor, Aunt Wang, has 1,000 yuan. Aunt Wang feels that it is not safe to keep the money at home and there is no interest, so she decides to deposit the money in the bank.

As a result, the bank's deposit account increased by 1,000 yuan.

If the bank locks this money in the vault and waits for Aunt Wang to withdraw it:

Since Aunt Wang is not in a hurry to withdraw the money, the bank slaps its thigh and decides to lend this 1,000 yuan to Mr. Wu to earn loan interest.

Mr. Wu took the borrowed money and immediately went to Mr. Li's store to buy a pair of shoes, paying 1,000 yuan.

At this time, the shop owner, Mr. Li, has 1,000 yuan, but Mr. Li feels that it is not safe to keep the money at home and there is no interest, so he deposits the money back into the bank.

**At this time, the bank's deposit account increased by another 1,000 yuan, with a total deposit of 2,000 yuan.**

At this point, the bank cannot just wait for the shop owner, Mr. Li, to withdraw the 1,000 yuan.

So the bank lends the money again.

This process of depositing money and lending money can continue indefinitely. Each time money is deposited, the bank can make a loan.

This creates an infinite amount of money.

This process is called money creation.

This game can go on forever.

But there is a problem:

After all, the bank needs to make a profit, and it is unnecessary to keep all the money idle in the vault.

The bank is a large pool of funds, with customers constantly depositing money, and customers do not withdraw all the money at once.

Therefore, the central bank requires banks to divide the money deposited by customers into two parts: one part can be used for lending to earn profits, and the other part is deposited with the central bank to ensure that depositors can withdraw their deposits and for fund clearing when needed.

**The money that banks hand over to the central bank for customers' withdrawal needs is called reserve.**

No.

The central bank sets a minimum level of reserves that banks must hold, which is called the statutory reserve requirement.

The proportion of reserves to total deposits is called the reserve requirement ratio.

The formula is as follows:

Because banks vary in size and have different liquidity risks, the central bank sets different statutory reserve requirement ratios for different types of banks.

Of course.

The excess reserves held by banks above the minimum statutory level are called excess reserves.

What changes will occur in the money creation process with reserves?

Let's simulate it again, assuming a reserve requirement ratio of 10%.

After the bank deposits the reserves, the remaining deposits are lent to Mr. Wu.

Mr. Wu spends 900 yuan at Mr. Li's store, and Mr. Li has 900 yuan, which he deposits back into the bank.

After the bank deposits 10% of the reserves, the remaining deposits of 900-90=810 yuan are used for lending, and this process continues.

But because of the reserves, not all deposits can be lent out, so an infinite amount of money cannot be created.

In the above example, with an initial deposit of 1,000 yuan and a reserve requirement ratio of 10%, a total of 10,000 yuan of money supply was created, magnifying it by 10 times.

**This magnification of 10 times is called the deposit creation multiplier.**

The size of the deposit creation multiplier is related to the reserve requirement ratio. Without considering cash leakage such as "you stuffing cash in the ceiling and not circulating it," the deposit creation multiplier is the reciprocal of the reserve requirement ratio.

The above formula can be derived through a geometric progression. Interested students can calculate it.

We can also understand the relationship between the deposit creation multiplier and the reserve requirement ratio in this way.

The lower the reserve requirement ratio, the less money is kept in the central bank, and the more deposits the bank can freely use for lending, resulting in a higher deposit creation multiplier.

In short, after the reserve requirement ratio cut, sufficient liquidity can be released to support the real economy, promote the continuous recovery and improvement of the real economy.

The central bank effectively increases the stable source of funds for financial institutions through the reserve requirement ratio cut, ensuring reasonable credit growth and better support for key areas and weak links.

At the same time as announcing the reserve requirement ratio cut, the governor of the central bank also announced a reduction in the "agricultural and small business" re-lending and rediscount rates on January 25, 2024.

This interest rate cut reduces the rates by 0.25%, from 2% to 1.75%.

By partially reducing the rediscount and re-lending rates, the central bank continues to promote the stability and moderate reduction of the overall social financing cost.

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