Responding to my comment on the PBOC’s move last month to lower reserve requirements on Chinese banks’ foreign-currency deposits, multiple readers made connections to Turkish banks. The connection may offer some insight on offshore dollar reserve requirements more generally.
Like Chinese banks, Turkish banks must post reserves against their foreign-currency deposits. My understanding draws in part from the careful analysis of Hasan Cömert and T. Sabri Öncü, see here and the references therein. The requirement originated as part of Turkey’s liberalization of international trade and finance in the 1980s. The country’s banks were allowed to create FX-denominated deposits from 1984, and the reserve requirement came into effect shortly thereafter.
How do these reserves work? Mechanically, the Turkish central bank (CBRT) maintains a dollar account at the New York Fed. Turkish banks post the majority of their dollar-denominated reserves by transfering funds into this account. CBRT in return creates a liability, its obligation to return those reserves to the bank. In other words, CBRT creates a dollar reserve asset for its banking system by issuing claims on the dollars it holds in custody. At the Fed, the CBRT’s deposits are recorded as “Foreign official” deposit liabilities, so the whole picture looks something like this:
The point is that the central bank of a country other than the US can exert some control over its banks offshore dollar deposits, by imposing on them the requirement to obtain onshore dollars in New York. Increasing the fraction of deposits that must be held in this way makes it more costly for banks to create offshore dollars; lowering it, as China did earlier this month, makes it easier to create offshore dollars.
More and more, I suspect the PBOC’s move has more to do with offshore dollar creation in China than it does with freeing up dollar-denominated reserves.