What is a 'Bank Reserve'

A bank reserve is the currency deposit that 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. Working Reserves

    Working reserves, or excess reserves, are reserves held by banks ...
  2. Reserve Requirements

    Reserve requirements refer to the amount of cash that banks must ...
  3. Excess Reserves

    Excess reserves are capital reserves held by a bank or financial ...
  4. Fractional Reserve Banking

    Fractional reserve banking is a system in which only a fraction ...
  5. Wednesday Scramble

    The Wednesday scramble consists of last-minute borrowing by banks ...
  6. Net Borrowed Reserves

    Net Borrowed Reserves is the difference between the amount a ...
Related Articles
  1. Investing

    How the Federal Reserve Devises Monetary Policy

    Learn about the tools the Federal Reserve uses to influence interest rates and economic conditions. Find out the types of action a central bank may take.
  2. 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.
  3. 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.
  4. Investing

    Analyzing a bank's financial statements

    In this article, you'll get an overview of how to analyze a bank's financial statements and the key areas of focus for investors who are looking to invest in bank stocks.
  5. Personal Finance

    Where to Put Your Cash: Call Deposit vs. Time Deposit Accounts

    Time deposit accounts and call deposit accounts allow customers to earn higher interest in exchange for less access to their cash.
  6. Investing

    3 Mutual Funds to Avoid During U.S. Rate Hikes (FRBAX, FSRBX)

    Learn why banks may not receive the traditional benefits from rising interest rates, and discover three financial mutual funds to avoid.
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. Who determines interest rates?

    Learn who determines interest rates. In countries using a centralized banking model, interest rates are determined by the ... Read Answer >>
  4. What are the implications of a low federal funds rate?

    Find out what a low federal funds rate means for the economy. Discover the effects of monetary policy and how it can impact ... Read Answer >>
Trading Center