Challenges of Reducing Interest Expenses on the Minimum Reserve in Small Open Economies - The Case of Hungary

Several central banks responded to the challenges posed by enlarged central bank balance sheets reported at the beginning of the 2020s and the higher interest rates resulting from the inflation shock by raising reserve requirement ratios and lowering the interest rates paid on the reserve requirement. After providing the relevant theoretical background, a brief historical overview and international examples, this paper examines the reform of the Magyar Nemzeti Bank’s reserve requirement system between 2022 and 2024 as a case study. It presents the impact the steps may have had on banking behaviour and the market yield environment, and the responses of the central bank. Based on Hungarian experience, there are significant, strong limitations on reducing the interest rate paid on the minimum reserve: given the overall interest rate environment, such a move may reduce central bank interest expenses as a technical consequence, but this may be limited by the fact that the change may have unintended consequences for the general financial market environment and foreign currency availability. These unintended consequences may vary over time and space, depending on the economic-financial situation of the country and thus very cautious introduction should be considered. The Hungarian experience may be particularly relevant for small open economies that have less developed financial markets and use their own currency.