What is the 'Bank Reserve'

Bank reserves are the currency deposits that are not lent out to a bank's clients. A small fraction of the total deposits is held internally by the bank in cash vaults or deposited with the central bank. Minimum reserve requirements are established by central banks in order to ensure that the financial institutions will be able to provide clients with cash upon request.

BREAKING DOWN 'Bank Reserve'

Bank reserves are typically held by financial institutions to avoid bank runs and have sufficient cash on hand, should an unexpected and large withdrawal request come up. Bank reserves are divided into required reserves and excess reserves. Because of the banking industry's importance to the economy, national authorities regulate banks by obligating them to hold a certain amount of required reserves with central banks.

Excess reserves represent any vault cash that banks hold that is in excess of the required reserves amount. Banks typically have low incentive to maintain excess reserves because cash earns the rate of return of zero and can lose value over time due to inflation. Thus, under normal circumstances, banks minimize their excess reserves and lend out money to clients rather than holding cash in their vaults. Bank reserves decrease during periods of economic expansion and increase during recessions.

Required Reserves

According to the Federal Reserve Board's regulation, the required reserves represent the amount of funds a bank must hold in its cash vault or deposit with the central bank against certain liabilities. The reserve ratio determines the required reserve, and it varies by the amount deposited in net transaction accounts, which include demand deposits, automatic transfer accounts and share draft accounts. Net transactions are calculated as the total amount in transaction accounts minus funds due from other banks and less cash in the process of collection.

The required reserve ratio can be used by national authorities as a tool to implement monetary policies. Through this ratio, a central bank can influence the amount of funds available for borrowing. Beginning in October 2008, the Federal Reserve began paying interest to the banks for required and excess reserves as a way to infuse more liquidity into the U.S. monetary circulation. The rates on required and excess reserves are determined separately and depend on the targeted federal funds rate.

Excess Reserves

Banks typically keep excess reserves at a minimum, because these reserves do not earn any interest. However, because the Federal Reserve engaged in an accommodating monetary policy after December 2008, the interest rate at which banks could originate their loans decreased dramatically. The banks took funds injected by the Federal Reserve and kept them as excess reserves, which are earning an essentially risk-free interest rate subsequent to the policy change in 2008. For this reason, the amount of excess reserves spiked after 2008, despite an unchanged required reserve ratio.

RELATED TERMS
  1. Working Reserves

    Reserves held by banks above the required minimum level - or ...
  2. Reserve Ratio

    The portion (expressed as a percent) of depositors' balances ...
  3. Reservable Deposit

    A bank deposit subject to reserve requirements. Reserve requirements ...
  4. Excess Reserves

    Capital reserves held by a bank or financial institution in excess ...
  5. Net Borrowed Reserves

    A statistic released in weekly Federal Reserve data showing the ...
  6. Lagged Reserves

    A method of bank reserve calculation whereby the financial institution ...
Related Articles
  1. Personal Finance

    Explaining the Reserve Ratio

    Reserve ratio is the amount of cash a bank must keep in its bank vaults or deposit into a central, governing bank.
  2. Financial Advisor

    Why Banks Don't Need Your Money to Make Loans

    Contrary to the story told in most economics textbooks, banks don't need your money to make loans, but they do want it to make those loans more profitable.
  3. Personal Finance

    What is Fractional Reserve Banking?

    Fractional reserve banking is the banking system most countries use today.
  4. Insights

    Regional Banks Give The Fed A National Perspective

    We all know that the Federal Reserve utilizes monetary policy to control the economy, but what do the 12 regional Federal Reserve Banks do?
  5. Insights

    How Central Banks Control The Supply Of Money

    A look at the ways central banks pump or drain money from the economy to keep it healthy.
  6. Insights

    How The Federal Reserve Manages Money Supply

    Find out how the Fed manages bank reserves and this contributes to a stable economy.
  7. Personal Finance

    What Does a Central Bank Do?

    A central bank oversees a nation’s monetary system.
  8. Insurance

    How the Federal Deposit Insurance Corporation (FDIC) Works

    Learn more about the Federal Deposit Insurance Corporation (FDIC) and what happens to your deposits over $250,000 if a member bank fails.
RELATED FAQS
  1. What do banks do to control the bank reserve?

    Understand what the Federal Reserve does in order to expand or contract the economy. Learn what depository institutions can ... Read Answer >>
  2. How do central banks acquire currency reserves and how much are they required to ...

    A currency reserve is a currency that is held in large amounts by governments and other institutions as part of their foreign ... Read Answer >>
  3. What happens if the Federal Reserve lowers the reserve ratio?

    Learn about the Federal Reserve's monetary policy and the tools it uses to control it. Understand what happens if the Federal ... Read Answer >>
  4. Who determines the reserve ratio?

    Understand what the Federal Reserve is and what it regulates in the U.S. economy. Learn about the reserve ratio and how the ... Read Answer >>
  5. Which nations' economies have reserve ratios?

    Learn more about the inconsistent imposition of depository banking reserve ratios, and why the United States stands alone ... Read Answer >>
  6. How must banks use the deposit multiplier when calculating their reserves?

    Explore the relationship between the deposit multiplier and the reserve requirement, and learn how this limits the extent ... Read Answer >>
Trading Center