While all banks are required to maintain a specific amount of bank reserves, the banks themselves do not control the minimum requirement of bank reserves. Instead, the central bank sets a minimum reserve requirement that requires a bank to keep a specific amount of cash on hand each night. These banks can either hold the cash in their vaults or with the local Federal Reserve bank.

What Is a Bank Reserve and Why Is It a Requirement?

A bank reserve is the amount of funds that a depository institution such as a bank or credit union holds on hand in case of a bank run or to cover specific bank liabilities. All bank reserves must be either vault cash held within the actual bank or keep their bank reserves as deposits in Federal Reserve banks.

The Federal Reserve sets a minimum requirement for bank reserves that all depository institutions must have on hand, at a minimum. Individual banks can elect to have more reserves than the minimum requirement, but all banks must have at least the minimum requirement on hand.

The Federal Reserve uses the minimum requirement of bank reserves to control the liquidity in the market and induce either a expansionary monetary policy or a contractionary monetary policy.

How Does the Federal Reserve Control Bank Reserves?

The Federal Reserve controls all depository institutions bank reserves based on a required reserve ratio. This required reserve ratio is normally a variable percentage based on the size of the depository institution and the total deposit amounts.

If the Federal Reserve wants to expand the economy, it reduces the required reserve ratio; if it wants to contract the economy, it increases the reserve ratio.

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