Remuneration Scheme for Reserves at the Central Bank of Bosnia and Herzegovina (CBBH)

The current remuneration scheme for reserves at the CBBH has several shortcomings that may lead to negative consequences.

Shortcomings in the Remuneration Scheme

• Negative Spread: Remunerating excess reserves above the return of short-term euro area assets exposes the CBBH to a negative spread, eroding its profitability.
• Costly Consequences: The current remuneration scheme may have cost the CBBH approximately BAM 7.7 million in 2018 due to the negative interest rate charge on excess reserves.

Risk of Speculative Short-Term Capital Flows

The CBBH is exposed to a risk of speculative short-term capital flows if it remunerates reserves above euro area interest rates, which can further erode the coverage ratio. The current market conditions do not change the fundamental assumption about the CBBH opportunity cost, which continues to be represented by the return of short-term euro area assets.

Distortive Effects on Financial Intermediation

The remuneration of banks’ reserves at a rate different from their opportunity cost is distortive from a financial intermediation perspective. If reserve requirements are remunerated substantially below market rates, it acts as a distortionary tax on financial intermediation that banks pass on to borrowers through higher interest rates or to savers and depositors in general through lower deposit rates.

Impact on Foreign Currency Intermediation

The fulfillment of reserve requirements for foreign currency liabilities encourages foreign currency intermediation at the expense of domestic intermediation. In a system where reserve requirements are fulfilled in local currency, all else being equal, the amount of foreign currency loans can be equal to foreign currency deposits. At the same time, domestic currency deposits will be used to fulfill reserve requirements for both currencies, limiting available funds for domestic currency credit growth.

Mitigating Factors: Indexed Loans and Domestic Currency Borrowing

The money multiplier effect in BiH is mitigated by indexed loans in local currency. Many loans are provided in local currency with a currency clause linking loan principal and interest payments to the exchange rate. This reduces the risk of foreign currency lending and encourages domestic currency borrowing.