What is a 'Bank Reserve'

A bank reserve is the currency deposit which is not lent out to the 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. Reserve Ratio

    The reserve ratio is the portion of depositors' balances that ...
  2. Lagged Reserves

    Lagged Reserves is a method of bank reserve calculation whereby ...
  3. Fractional Reserve Banking

    Fractional reserve banking is a system in which only a fraction ...
  4. Reserve Maintenance Period

    The reserve maintenance period is the time frame in which banks ...
  5. Adjustment Credit

    Adjustment credit is a short-term loan, which a Federal Reserve ...
  6. Regulation I

    Regulation I is a regulation stipulating that any bank that becomes ...
Related Articles
  1. Insights

    How the Federal Reserve Manages Money Supply

    The Federal Reserve was created to help reduce the injuries inflicted during the slumps and was given some powerful tools to affect the supply of money.
  2. Insights

    A Primer On Reserve Currencies

    For nearly a century, the U.S. dollar has served as the world's premier reserve currency, but the future is uncertain.
  3. 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.
  4. Insights

    Central Bank

    They print money, they control inflation, they are known as the "lender of last resort". Check out the role of Central Bank nd how its role evolved overtime.
  5. Trading

    10 Countries With The Biggest Forex Reserves

    Without adequate reserves, a nation's economy can grind to a halt. Here are the 10 nations with the biggest forex reserves.
  6. Personal Finance

    How the Federal Reserve Affects Your Mortgage

    The Federal Reserve can impact the cost of funds for banks and consequently for mortgage borrowers when maintaining economic stability.
  7. Insights

    How Much Influence Does The Fed Have?

    Find out how current financial policies may affect your portfolio's future returns.
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. What is the difference between the deposit multiplier and the money multiplier?

    Explore the deposit multiplier and the money multiplier, two fundamental concepts of Keynesian economics, and learn how they ... Read Answer >>
  4. What economic indicators are important to consider when investing in the banking ...

    Find out which economic indicators are most useful for investors in the banking sector, especially those influenced by central ... Read Answer >>
  5. Market operation and its effect on Money Supply

    Understand how open market operations affect the supply of money in the economy and learn the specific ways the Federal Reserve ... Read Answer >>
Trading Center