A:

In economics, required reserves play an important role in ensuring the stability of banks and how a central bank conducts its monetary policy. Reserve requirements represent an amount of funds that a central bank requires banks to hold in reserve against deposit liabilities. Bank reserves are typically calculated based on the reserve ratio, which is a percent of deposits, and must be held as vault cash or deposits with a central bank. Reserve requirements affect banks and their shareholders by making depositary institutions more stable and less susceptible to sudden bank runs in case of a large and unexpected need for liquidity. However, bank reserves present an opportunity cost to banks and their shareholders, as financial institutions forgo profits that could be earned on the required reserves.

Bank Reserves

The amount of required reserves is determined based on the reserve ratio specified by a central bank. In the United States, the Federal Reserve Board's Regulation D specifies the reservable liabilities, which are net transaction accounts such as checking and savings accounts and various transfer accounts. Since January 2015, net transaction accounts with a value less than $14.5 million require zero required reserves, while accounts with a value in excess of $14.5 million but less than $103.6 million require 3% required reserves. All net transaction accounts with a value more than $103.6 million must have 10% required reserves.

Effect on Banks' Shareholders

The required reserve system was established to enhance stability of financial institutions in case of sudden runs on banks. However, this tool had limited success in preventing bank panics. Instead, the United States uses reserve requirements as a tool in its monetary policy.

Reserve requirements also impose opportunity costs on banks and their shareholders in the form of forgone income that banks could have earned on other investment projects. The opportunity costs grow significantly as the level of reserve requirements increases for large deposit liabilities. As a mitigating factor, since 2008, the United States pays interest on bank reserves to compensate banks for implicit tax imposed on them.

RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. Why do commercial banks borrow from the Federal Reserve?

    Learn how commercial banks borrow from the Federal Reserve to meet minimum reserve requirements, and discover the pros and ... Read Answer >>
  4. 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 >>
  5. Why would the Federal Reserve change the reserve ratio?

    Understand the Federal Reserve's monetary policy and the tools it uses to change that monetary policy. Learn about the reserve ... Read Answer >>
  6. How does the Federal Reserve's set discount rate affect my personal finances?

    Discover how the Federal Reserve implements its chosen monetary policy through its discount rates, and how these actions ... Read Answer >>
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. Insights

    What Do the Federal Reserve Banks Do?

    These 12 regional banks are involved with four general tasks: formulate monetary policy, supervise financial institutions, facilitate government policy and provide payment services.
  3. Personal Finance

    What is Fractional Reserve Banking?

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

    How The Federal Reserve Manages Money Supply

    Find out how the Fed manages bank reserves and this contributes to a stable economy.
  6. Trading

    How Inflation-Fighting Techniques Affect The Currency Market

    Central banks use these strategies to calm inflation, but they can also provide longer-term clues for forex traders.
  7. Investing

    How Does Reserve Work and Make Money?

    Learn what Reserve is and how it makes money through securing reservations at fine dining establishments for clients willing to pay for its premium service.
  8. Personal Finance

    Retail Banking Vs. Corporate Banking

    Retail banking is the visible face of banking to the general public. Corporate banking, also known as business banking, refers to the aspect of banking that deals with corporate customers.
  9. Insights

    What's the 1913 Federal Reserve Act?

    The 1913 Federal Reserve Act was a pivotal congressional act that helped establish the Federal Reserve System as it exists today. It is one of the United States financial system’s most influential ...
RELATED TERMS
  1. Reserve Ratio

    The portion (expressed as a percent) of depositors' balances ...
  2. Reserve Requirements

    Requirements regarding the amount of funds that banks must hold ...
  3. Reservable Deposit

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

    A measurement of a bank's reserves that is equal to the difference ...
  5. Working Reserves

    Reserves held by banks above the required minimum level - or ...
  6. Wednesday Scramble

    Last-minute buying and selling of eligible reserves that takes ...
Hot Definitions
  1. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  2. Promissory Note

    A financial instrument that contains a written promise by one party to pay another party a definite sum of money either on ...
  3. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
  4. Fixed Asset

    A long-term tangible piece of property that a firm owns and uses in the production of its income and is not expected to be ...
  5. Absolute Advantage

    The ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost ...
  6. Nonce

    Nonce is a number added to a hashed block, that, when rehashed, meets the difficulty level restrictions.
Trading Center