Reserve Requirement Analysis using a Dynamical System of a Bank based on Monti-Klein model of Bank's Profit Function

TL;DR

This paper develops a dynamical system model of a bank's deposits and loans based on the Monti-Klein profit function to analyze reserve requirements and their impact on bank behavior under Indonesian regulation.

Contribution

It introduces a novel dynamical system model linking bank profit functions to reserve requirement analysis, considering LDR effects and regulatory context.

Findings

Different initial L and D volumes lead to significantly different solution behaviors.

The model demonstrates the impact of LDR on bank deposit and loan dynamics.

Regulatory influences can alter the stability and evolution of bank financial variables.

Abstract

Commercial banks and other depository institutions in some countries are required to hold in reserve against deposits made by their customers at their Central Bank or Federal Reserve. Although some countries have been eliminated it, this requirement is useful as one of many Central Bank's regulation made to control rate of inflation and conditions of excess liquidity in banks which could affect the monetary stability. The amount of this reserve is affected by the volumes of the commercial bank's loan and deposit, and also by the bank's Loan to Deposit Ratio (LDR) value. In this research, a dynamical system of the volume of deposits (dD/dt) and loans (dL/dt) of a bank is constructed from the bank profit equation by Monti-Klein. The model is implemented using the regulation of Bank of Indonesia, and analysed in terms of the behaviour of the solution. Based on some simplifying assumptions in this model, the results show that eventhough the LDR values at the initial points of two solutions are the same, the behavior of solutions will be significantly different due to different magnitude of L and D volumes.