Determinants of Excess Reserves in the Banking System of Papua New Guinea

The accumulation of excess reserves in the banking system of PNG may have undesirable implications on the financial system, macroeconomic stability and monetary policy implementation. Hence, this paper examines the factors that induce commercial banks to hold unremunerated excess reserves. The paper employs an ARDL model to estimate the determinants of excess reserves using monthly time-series data for the period January 2002 to December 2017. The model includes three precautionary variables of volatility of demand deposits, discount rate and cash reserve requirement and four involuntary variables of foreign reserve inflows, private sector lending, private sector deposits and treasury bill rate. The selection of these variables is determined by data availability and relevance to the economy of PNG. The findings suggest that the discount rate, volatility of demand deposits and private sector deposits significantly contribute to the accumulation of excess reserves. In contrast, foreign exchange reserves, private sector credit and the treasury bill rate effectively reduce excess reserves pressure in the banking system. However, the cash reserve requirement is not effective in influencing the demand for excess reserves. The empirical analysis concludes that involuntary variables are the leading determinants of excess reserves in PNG. Hence, the central bank should review the involuntary variables to take appropriate policy actions in order to reduce the level of excess reserves in the banking system.