What is the 'Reserve Ratio'
The reserve ratio is the portion of depositors' balances that banks must have on hand as cash. This is a requirement determined by the country's central bank, which in the United States is the Federal Reserve. The reserve ratio affects the money supply in a country at any given time.
BREAKING DOWN 'Reserve Ratio'
If the Federal Reserve, for example, determined the reserve ratio to be 11%, this means all banks must have 11% of their depositors' money on reserve in the bank. So, if a bank has deposits of $1 billion, it is required to have $110 million on reserve.
Depository institutions in the United States are required to hold reserves in the form of vault cash with the Federal Reserve. The reserve amount is referred to as the reserve requirement because it is the amount banks must hold in reserves against liabilities or loans outstanding. The reserve amount is specified by the Federal Reserve Board’s Regulation D. Regulation D created a set of uniform reserve requirements for all depository institutions with transaction accounts, and requires banks to provide regular reports to the Federal Reserve.
Reserve requirements are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. Within limits specified by law, the Board of Governors of the Federal Reserve has the sole authority over changes in reserve requirements. Banks must hold reserves in the form of vault cash or deposits with Federal Reserve Banks. On Oct. 1, 2008, the Federal Reserve began paying interest to banks on these reserves. This rate is referred to as the interest rate on required reserves (IORR). There is also an interest rate on excess reserves (IOER). The Federal Reserve uses both rates as a proxy for the fed funds rate, which was raised for the first time in nearly a decade on December 2015. As of Dec. 17, 2015, both rates are 0.50%. Interest is paid out to banks in the form of cash, not in reserves like quantitative easing.
The reserve ratio depends on the bank's net loans, and the Federal Reserve measures this with net transactions. As of Jan. 21, 2016, the reserve ratio for a depository institution with less than $15.2 million in deposits is zero percent. If net transactions are between $15.2 million and $110.2 million, the reserve ratio is 3 percent. If net transactions are higher than $110.2 million, the reserve ratio is 10%. The majority of banks in the United States fall into the last category.