Malaysia: Reserve Requirements, AFC

Bank Negara Malaysia (BNM) unpegged the ringgit in July 1997, days after Thailand floated the baht. Ringgit depreciation and adverse investor sentiment worsened, contributing to a domestic liquidity shortage and capital flight. Malaysia experienced market instability in the early months of 1998, particularly pressure on its exchange rate, foreign currency reserves, and interest rates. At the same time, disruptions in the domestic money market and loan intermediation process caused an increase in lending rates, which resulted in debt servicing problems and weakened financial stability. To facilitate lending and productive economic activity, BNM twice lowered the statutory reserve requirement (SRR) at commercial banks, merchant banks, and finance companies on February 16 and July 1, 1998. BNM simultaneously offset the additional liquidity added to the banking system by reducing direct central bank lending to the interbank market and raised the three-month intervention rate (three-month interbank rate) to better reflect liquidity conditions in the market. When inflationary pressure subsided toward the end of summer 1998, BNM began to pursue monetary easing. Thus, the central bank did not sterilize the SRR reductions on September 1 and 16, 1998. BNM paired these latter, unsterilized SRR reductions with a lower three-month interbank rate to promote liquidity and enhance banking institutions' lending capacity. The initial SRR reductions would have released MYR 22 billion (USD 5.8 billion) into the banking system, had BNM not lowered direct lending to the interbank market. The latter SRR reductions released MYR 15 billion into the banking system.