The Bangko Sentral ng Pilipinas (BSP) has signalled that it will reduce banks’ reserve requirement ratio (RRR) by October or November on top of at least three 25 basis points (bps) interest rate hikes as monetary response to high inflation.

“Our preference is that RR (ratio) cut will come maybe a month or two before we withdraw the assistance to the micro, small and medium enterprises (MSMEs),” said BSP Governor Benjamin E. Diokno on Monday, June 13, in a virtual press chat.

“There’s an alternative compliance (to RR) so as we withdraw that, we will probably consider the RR cut. This program (will expire) sometime in the fourth quarter,” said Diokno.

Reducing the RRR will not affect the Monetary Board’s policy stance since the BSP considers the move as an operational adjustment. The market however views an RRR cut as an easing of monetary policy.

Since 2020, the BSP allows banks to use loans to MSMEs and large enterprises not affiliated with conglomerates as alternative compliance with the RR against deposit liabilities and deposit substitutes. It is one of BSP’s anti-pandemic measures to make sure banks are continuously supporting key sectors of the economy.

The alternative compliance with RR is until December 29 only but “subject to early closure, if warranted and with prior notice.”

As BSP often tells the market, an RRR cut is a move intended to be an operational adjustment to facilitate the BSP’s shift to market-based instruments for managing liquidity in the financial system, particularly the term deposit facility and the BSP securities.

The BSP has started raising its key rate last May 19, when the Monetary Board increased the interest rate by 25 bps.

The finance department-bound Diokno and incoming BSP governor, Monetary Board member Felipe M. Medalla, has both signalled another 25 bps rate hike this month, during its June 23 policy meeting, and on Aug. 18.

The main objective of BSP’s monetary operations is to control and manage inflation which the BSP as of May 19 forecasts will average at 4.6 percent for 2022 and 3.9 percent in 2023. The 2022 inflation projection exceeds the government target of two percent to four percent. In April, the inflation rate surpassed the five-percent level at 5.4 percent.

In 2020, the Monetary Board approved a 400 bps cut to RR ratio but the BSP only reduced the ratio by 200 bps, seeing no further need to use up the entire 400 bps authority to slash the RR ratio.

Since a lower RR ratio reduces intermediation costs, the BSP wants to reduce the ratio to single-digit levels by 2023.

The BSP’s RR ratio of 12 percent for big banks and 14 percent for non-banks is considered one of the highest in the region.

The BSP’s primary monetary policy instrument is the interest rate on its RRP facility. But BSP has the option to reduce banks’ RR ratio and its weekly auctions for the term deposit facility and the BSP securities facility.