A new reason for deposit rates to rise: NBU announces changes to bank reserve requirements

On 27 March, the NBU announced that from 11 May on, banks would have to make mandatory reserves for retail deposits with a term of up to three months under the new rules. In effect, the deposit ratio for short-term deposits will become stricter and will be equal to the same reserve requirement for private clients' funds on current accounts. The NBU justifies these changes by arguing that it is time to make long-term deposits more attractive to individuals. It, in turn, will allow free hryvnia to be transferred from current accounts to deposits and remove the threat to the foreign exchange market.

Mind has found out what is changing in the provisioning conditions for banks and where deposit rates are heading in general.

How does the NBU review bank reserve requirements? It is not the first reserve requirements revision for banks in 2023. For example, on 11 February, the NBU increased by 5 pp the required reserve ratios for demand deposits on current accounts of legal entities and individuals, deposits and funds on current accounts of other non-resident banks, and loans received by banks from international organisations. As a result, the reserve requirements increased from 5% to 10% for national currency funds and from 15% to 20% for foreign currency funds.

A month later, on 11 March, the NBU made another increase. This time, the NBU increased the required reserve ratio for demand deposits and current accounts of individuals in both national and foreign currencies by 10 pp. That is, to 20% and 30%, respectively.

In addition, the NBU allowed banks to cover part of the required reserves with benchmark government domestic bonds. These are special series of government bonds issued by the Ministry of Finance. Banks that purchase them are entitled to compensate up to 50% of their total required reserves with these bonds.

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What innovations will take place on 11 May? The NBU announced the next revision of the ratios back on 16 March, during a briefing that summarised its monetary policy decisions. At that time, the NBU announced that starting from 11 May 2023, the preferential ratios for mandatory reserves on term funds on the accounts of individuals in national and foreign currencies would apply only to deposits with a maturity of three months or more.

The NBU has now provided detailed information on what will change in May. Namely:

• The required reserve ratio for term accounts and deposits of individuals with an initial maturity of up to 92 calendar days (inclusive) for funds in national currency will be 20%, and for funds in foreign currency – 30%;
• The  reserve ratio for retail deposits with an initial maturity of 93 calendar days or more will remain unchanged. It will be 0% for national currency funds and 10% for foreign currency funds;
• The coverage mechanism by the benchmark government bonds will not apply to the part of the required reserves formed on retail deposits with a maturity of up to three months, which corresponds to 10% of the reserve base.

To what end is this being done? The NBU states that the main goal of gradually tightening reserve requirements is to encourage banks to accumulate more hryvnia time deposits from households. One of the main tools for attracting depositors are, of course, high deposit rates.

Accordingly, banks that want to use preferential reserve requirements will simply have to increase the yield on deposits with maturities of 6-12 months or more to increase the share of such deposits in their portfolios.

The inflow of households' funds to term accounts will have another effect – reducing risks to the foreign exchange market and the hryvnia exchange rate. As of 1 February 2023, according to the NBU, UAH 591 billion of the UAH 929 billion of retail deposits in banks were on demand accounts. If we hypothetically assume that customers withdraw this amount in one fell swoop and start buying foreign currency, no amount of foreign exchange reserves will be enough to cover this demand.

Amount of private deposits in banks

Source: NBU data

Moreover, the NBU has already announced plans to conduct currency liberalisation. This means that it is extremely important for the NBU to 'dry up' excessive free liquidity in the banking system before doing so.

By the way, the NBU expects that the total amount of required reserves that banks will have to form after 11 May will increase by an estimated UAH 17 billion.

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What is happening with deposit rates? In general, if we look at the dynamics of deposit rates, the rate of growth in yields has accelerated.

For example, in the period from 31 December 2022 to 10 February 2023, before the aforementioned reserve requirements came into effect, the average yield on hryvnia deposits increased by 0.4-0.7 pp to 11.6-13.2% per annum, according to the Ukrainian Index of Retail Deposit Rates (UIRD). However, in the period from 11 February to 30 March inclusive, banks raised interest rates on hryvnia deposits by an average of 1-1.4%, to 12.9-14.6% per annum.

For comparison, it was the level of deposit yields in December 2019, before banks cut them en masse.

Ukrainian Index of Retail Hryvnia Deposit Rates (UIRD)

Source: NBU data

Moreover, many financial institutions are already making deposits not only for a year but for 24–36 months. And they offer the most attractive yields. It is a clear sign that the new provisioning policy is working.

How much more can deposits go up? Taking into account the upcoming changes to the provisioning requirements, we expect the marginal rates on hryvnia deposits to reach 20-21% in the next two to three months.

However, yields are unlikely to go beyond this level. Banks still have little to do with their money: lending is barely functioning. The main source of income for the banking sector remains NBU certificates of deposit.

Certain financial institutions will clearly have incredibly generous offers. However, this is likely to be a one-off event, and it will come from those banks whose financial condition raises questions.