Reserve requirements, excess liquidity and bank lending: Evidence from the Caribbean and Central America

This paper investigates the impact of two major central bank policy instruments, namely reserve requirements and policy rates, on individual banks operating in Central America and the Caribbean. Using information on 116 banks from 20 jurisdictions, we find that banks tend to reduce lending one year after a tightening of reserve requirements. From this perspective, adjustments in reserve requirements constitute an effective macroprudential countercyclical instrument for mitigating credit cycles, even in oligopolistic banking markets with high liquidity and less flexible exchange rates. In the banking markets of the small island economies, tighter reserve requirements are associated with increased credit risks after one year, perhaps reflecting increased risk-taking by banks in pursuit of higher yields. Lastly, we find that changes in policy rates exert little impact on the credit intermediation of banks.