Liquidity Reserve Requirement increase reduces lending towards agriculture—study

Liquidity Reserve Requirement increase reduces lending towards agriculture—study

Post was last updated: January 11, 2021

Increases in Liquidity Reserve Requirement (LRR) reduce lending towards the agriculture sector, a study by Africa Institute for Corporate Citizenship (AICC) has shown.

LRR is the amount of cash that commercial banks are allowed to have in line with deposits made by their customers, set by the Reserve Bank of Malawi (RBM).

The study employed secondary data from six commercial banks that were operational in the data period of between 2007 and 2017.

It tested three sets of relations including the impact of LRR on Total Liquidity Creation (TLC), the impact of liquidity levels on Agricultural Lending Levels (ALL) and the determinants of Total Credit (TC) in Malawi.

To test the relationship between liquidity and lending in the Malawi banking sector, the study adopted the panel regression framework while fixed effects and random effects models were using in the estimations.

The study found that, for the period under observation, LRR positively affected total liquidity creation and that the impact of liquidity levels on ALL was positive.

In general, Total Credit was positively determined by bank deposit growth and loan deposit ratios while LRR, TLC and Bank Capital affected total credit negatively.

In an interview, AICC Chief Executive Officer Felix Lombe added that control variables included bank capital, bank asset growth, bank deposit growth and loan to deposit ratio.

He said, from the empirical analysis, the study shows that banks created liquidity of about 1.2 percent of total industry assets over the study period.

“This could imply that an increase in Total Liquidity Creation does not automatically result into an increase of Total Credit. The findings further indicate that LRR had a negative effect on Agricultural Lending Levels. In periods where LRR went up Agricultural Lending Levels went down, possibly implying that banks shift to other sectors considered less risky even amidst rising liquidity levels,” Lombe said.

Ironically, LRR declined to K53 billion on Friday last week from K55.2 billion at the end of the first week of January in 2020.

Making a speech at the 2020 ICAM conference, Reserve Bank of Malawi Governor Wilson Banda said he banking industry maintained sufficient liquidity levels.

He indicated that, overall, the banking industry registered a liquidity ratio of 59.9 percent in September, against the prudential benchmark of 25.0 percent.

“All banks reported liquidity above the regulatory minimum benchmark,” he said.

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