What is a legal reserve?
A legal reserve refers to the minimum amount of cash assets which a financial institution is legally required to hold in reserve accounts on average against specified liabilities.
Every country has regulations governing the maintenance of legal reserves. Along with 27 other counties, Thailand is a Member of Basel III, an internationally agreed set of standards that aim to strengthen the regulation, supervision and risk management of internationally active banks. Basel III requires banks to maintain proper leverage ratios and keep certain levels of reserve capital.
Accordingly, commercial banks in Thailand are required to maintain reserve assets based upon the average over a fortnightly ‘maintenance period’. The reserve requirement ratio of local currency deposits stands at 1.0% of the previous period’s average level of a commercial bank’s liabilities base. The maintenance period is a fortnight in duration, beginning on Wednesday, and ending the second Tuesday thereafter.
Commercial banks in Thailand must hold reserves in two forms:
1. A non-remunerated current account deposited at the Bank of Thailand (BOT) maintained at no less than 0.8%; and
2. Vault cash kept at a commercial bank’s central cash centers of no more than 0.2%.
The liabilities base is made up of the following:
✓ All types of deposits;
✓ Borrowings through issuance of bills of exchange or promissory notes;
✓ Short-term foreign borrowings maturing within one year; and
✓ Other borrowings with index-linked returns or embedded financial derivatives.
Rationale
✓ Protects the financial institution against potential financial losses, such as those flowing from litigation.
✓ Assists the financial institution in upholding obligations and payment of claims, especially in situations of sudden withdrawals.
✓ Ensures that relevant monetary and exchange rate policies are duly fulfilled
✓ Storage of the nation’s wealth.
Foreign exchange reserves
Holding the required reserves in multiple foreign currencies would be administratively burdensome on banks. Consequently, monetary authorities are only required to hold reserves in domestic currencies; however, banks may also maintain separate foreign reserves for foreign currencies. Individual banks are certainly not expected to hold foreign reserves, and this tends only to be a function of the Central Bank. Nevertheless, there is nothing precluding a commercial bank from holding foreign reserves. In fact, it may be beneficial where they make substantial use of foreign exchange, as the central bank is more restricted in lending foreign currencies than domestic currency. These reserves are usually held in U.S. dollars, as it is the most traded currency in the world. To this end, Thailand’s foreign exchange reserves were measured at USD 234.4 billion as of March 2021.
Foreign exchange reserves are external assets which are held or controlled by the monetary authority and are readily available for use, such as direct financing of payment imbalances, indirect regulation of imbalances through intervention in exchange markets to affect the currency exchange rate, etc.
Notably, foreign exchange reserves are generally not physically held by the Central Bank itself. Out of convenience, these assets are often held in accounts with correspondent banks in foreign countries. As such, while the reserve is actually held in the foreign bank, it is held in an account owned by the domestic bank that has authority over that account. This is also known as a ‘Nostro Account’, which is principally used to simplify and facilitate foreign exchange and trade transactions. Mahanakorn Partners Group (MPG) often engages Nostro Accounts to facilitate and administer escrow services. In this sense, where MPG provides escrow services in a foreign currency, for example, USD, the Thai bank used does not have a deposit in Thailand, but rather, with a correspondent bank in New York.